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BILLING CODE 8011-01-M SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57083; File No. SR-CBOE-2007-151] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Proposed Rule Change Relating to Linkage Fees January 2, 2008. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on December 20, 2007, Chicago Board Options Exchange, Incorporated (“CBOE” or the “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II and III below, which Items have been substantially prepared by CBOE.
The Commission is publishing this notice to solicit comments on the proposed rule change from interested parties. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend its Options Intermarket Linkage (“Linkage”) fees. The text of the proposed rule change is available on the Exchange's Web site ( *http://www.cboe.org/legal* ), at the Exchange's Office of the Secretary and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, CBOE included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. CBOE has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, Proposed Rule Change 1. Purpose Under the Exchange's current Fees Schedule, Principal (“P”) and Principal Acting as Agent (“P/A”) orders 3 are charged a transaction fee of $.26 per contract. 4 Satisfaction orders are not assessed Exchange fees. Linkage fees are operating under a pilot program scheduled to expire on July 31, 2008. 3 Under the Plan for the Purpose of Creating and Operating an Options Intermarket Linkage (“Plan”) and Exchange Rule 6.80(12), which tracks the language of the Plan, a “Linkage Order” means an Immediate or Cancel Order routed through the Linkage as permitted under the Plan.
There are three types of Linkage Orders:
(i)“P/A Order,” which is an order for the principal account of a specialist (or equivalent entity an another Participant Exchange that is authorized to represent Public Customer orders), reflecting the terms of a related unexecuted Public Customer order for which the specialist is acting as agent;
(ii)“P Order,” which is an order for the principal account of an Eligible Market Maker and is not a P/A Order; and
(iii)“Satisfaction Order,” which is an order sent through the Linkage to notify a member of another Participant Exchange of a Trade-Through and to seek satisfaction of the liability arising from that Trade-Through. 4 Linkage orders in MNX, NDX, and RUT options are also charged a $.10 per contract surcharge fee. *See* CBOE Fees Schedule, Footnote 14. The Exchange proposes to increase its Linkage transaction fee from $.26 per contract to $.30 per contract. The proposed fee increase would help the Exchange partially offset its costs of crediting Linkage fees and related costs to Designated Primary Market-Makers (“DPMs”) pursuant to the Exchange's DPM Linkage Fees Credit Program. 5 The Exchange believes the proposed fee is reasonable in that it is significantly lower than Linkage fees currently charged by certain exchanges. 6 5 *See* CBOE Fees Schedule, Section 21. 6 The Exchange believes NYSEArca, Inc., charges $.50 per contract on electronically executed Linkage orders and the Boston Options Exchange charges $.45 per contract or $.50 per contract for Linkage orders in classes included in its make or take pricing structure. 2. Statutory Basis The proposed rule change is consistent with Section 6(b) of the Act 7 in general, and furthers the objectives of Section 6(b)(4) 8 of the Act in particular, in that it is designed to provide for the equitable allocation of reasonable dues, fees, and other charges among CBOE members and other persons using its facilities. 7 15 U.S.C. 78f(b). 8 15 U.S.C. 78f(b)(4). B. Self-Regulatory Organization's Statement on Burden on Competition CBOE does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others No written comments were solicited or received with respect to the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the **Federal Register** or within such longer period
(i)as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or
(ii)as to which the self-regulatory organization consents, the Commission will:
(A)By order approve such proposed rule change or
(B)institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov.* Please include File Number SR-CBOE-2007-151 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-CBOE-2007-151. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Section, 100 F Street, NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the CBOE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-CBOE-2007-151 and should be submitted on or before January 30, 2008. 9 17 CFR 200.30-3(a)(12). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 9 Florence E. Harmon, Deputy Secretary. [FR Doc. E8-151 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57095; File No. SR-CBOE-2007-65] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Order Granting Approval of a Proposed Rule Change as Modified by Amendment No. 1 Thereto Regarding Nullification and Modification of Transactions Executed on CBOE Stock Exchange January 3, 2008. On June 12, 2007, the Chicago Board Options Exchange, Incorporated (“CBOE” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 1 and Rule 19b-4 thereunder, 2 a proposed rule change to make various revisions to CBOE Stock Exchange (“CBSX”) Rule 52.4, which governs the nullification and modification of transactions executed on CBSX. On November 8, 2007, the CBOE submitted Amendment No. 1 to the proposed rule change. The proposed rule change, as amended, was published for comment in the **Federal Register** on November 27, 2007. 3 The Commission received no comment letters on the proposal. This order approves the proposed rule change as amended. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 *See* Securities Exchange Act Release No. 56818 (November 19, 2007), 72 FR 66205. The Exchange proposes to revise CBSX Rule 52.4 to:
(1)Require a request for review of a transaction to be made by only one of the following methods: telephone; facsimile; or e-mail (in order to simplify the process for those making requests);
(2)require such a request to be made within thirty minutes of the trade in question, or within forty-five minutes of the trade if that trade occurred within the first thirty minutes of trading in the product involved in the trade (in order to give more time for requests which, based on the Exchange's experience so far, is necessary);
(3)give the individual(s) who reviews transactions under the Rule the label of “designated official,” so that they need not be officers of the Exchange; and
(4)eliminate the requirement that the notification to the parties to the trade of the official's determination be given in writing and by the official. The aforementioned changes numbered
(1)and
(4)are based on, and conform CBSX Rule 52.4 to, NYSE Arca Equities Rules 7.10(b) and 7.10(c)(1), respectively. The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange 4 and, in particular, the requirements of Section 6(b) of the Act 5 and the rules and regulations thereunder. Specifically, the Commission finds that the proposal is consistent with Section 6(b)(5) of the Act, 6 in that it is designed to promote just and equitable principles of trade, serve to remove impediments to and perfects the mechanism of a free and open market and a national market system, and, in general, protect investors and the public interest. 4 In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 5 15 U.S.C. 78f(b). 6 15 U.S.C. 78f(b)(5). The Commission believes that the Exchange's proposal to revise its CBSX rule governing clearly erroneous transactions is appropriate. *It is therefore ordered,* pursuant to Section 19(b)(2) of the Act, 7 that the proposed rule change (SR-CBOE-2007-65), as amended, is hereby approved. 7 15 U.S.C. 78s(b)(2). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 8 8 17 CFR 200.30-3(a)(12). Florence E. Harmon, Deputy Secretary. [FR Doc. E8-155 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57094; File No. SR-CBOE-2007-154] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Relating to the Marketing Fee Program January 3, 2008. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on December 28, 2007, the Chicago Board Options Exchange, Incorporated (“CBOE” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the Exchange. CBOE has designated this proposal as one establishing or changing a due, fee, or other charge imposed by CBOE under Section 19(b)(3)(A)(ii) of the Act 3 and Rule 19b-4(f)(2) thereunder, 4 which renders the proposal effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 15 U.S.C. 78s(b)(3)(A)(ii). 4 17 CFR 240.19b-4(f)(2). I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change CBOE proposes to amend its Marketing Fee Program. The text of the proposed rule change is available at the Exchange, the Commission's Public Reference Room, and > *http://www.cboe.com* . II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change, and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. CBOE has substantially prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose CBOE proposes to amend its marketing fee program as follows. First, CBOE proposes to decrease the fee from $.30 to $.25 in the following Penny Pilot classes: equity options, OIH, SMH, XLE, and XLF. CBOE would continue to collect the marketing fee at the rate of $.10 per contract in DIA and SPY, and not collect the marketing fee in QQQQ and IWM. CBOE believes that this change would allow CBOE Market- Makers, RMMs, e-DPMs, or DPMs (collectively “market-makers”) to compete better for order flow in these option classes. Second, CBOE proposes to amend the fee such that the marketing fee would not apply to transactions in Penny Pilot classes resulting from orders executed through the Hybrid Agency Liaison under CBOE Rule 6.14 in which market-makers “step up” through the HAL system and trade with orders that are marketable against the NBBO when CBOE is not the NBBO. CBOE believes that this change would encourage market-makers to execute orders at CBOE at the NBBO. CBOE proposes to implement these changes to the marketing fee program beginning on January 2, 2008. CBOE is not amending its marketing fee program in any other respects. 2.Statutory Basis The Exchange believes that the proposed rule change is consistent with Section 6(b) of the Act 5 in general, and furthers the objectives of Section 6(b)(4) of the Act 6 in particular, in that it is designed to provide for the equitable allocation of reasonable dues, fees, and other charges among CBOE members. 5 15 U.S.C. 78f(b). 6 15 U.S.C. 78f(b)(4). B.Self-Regulatory Organization's Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C.Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were solicited or received with respect to the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing proposed rule change has been designated as a fee change pursuant to Section 19(b)(3)(A)(ii) of the Act 7 and Rule 19b-4(f)(2) 8 thereunder, because it establishes or changes a due, fee, or other charge imposed by the Exchange. Accordingly, the proposal will take effect upon filing with the Commission. At any time within 60 days of the filing of such proposed rule change the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. 7 15 U.S.C. 78s(b)(3)(A)(ii). 8 17 CFR 240.19b-4(f)(2). IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov* . Please include File Number SR-CBOE-2007-154 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-CBOE-2007-154. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of CBOE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-CBOE-2007-154 and should be submitted on or before January 30, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 9 9 17 CFR 200.30-3(a)(12). Florence E. Harmon, Deputy Secretary. [FR Doc. E8-157 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57093; File No. SR-NYSE-2007-127] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Eliminate Certain Regulatory Fees January 3, 2008. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (the “Act”), 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on December 31, 2007, the New York Stock Exchange LLC (“NYSE” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the NYSE. The NYSE has designated the proposed rule change as one concerned solely with the administration of the Exchange pursuant to section 19(b)(3)(A)(iii) of the Act 3 and Rule 19b-4(f)(3) thereunder, 4 which renders the proposed rule change effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 15 U.S.C. 78s(b)(3)(A). 4 17 CFR 240.19b-4(f)(3). I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change The NYSE proposes to eliminate, effective January 1, 2008, certain regulatory fees that NYSE Regulation, Inc. (“NYSE Regulation”) currently remits to the Financial Industry Regulatory Authority, Inc. (“FINRA”) and which FINRA has determined should be eliminated effective January 1, 2008. The text of the proposed rule change is available on NYSE's Web site at *http://www.nyse.com,* at NYSE's principal office, and at the Commission's Public Reference Room. II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the NYSE included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The NYSE has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to eliminate, effective January 1, 2008, certain regulatory fees that are charged to member organizations, including registered persons fees, branch office registration fees, credit extension fees, and certain other regulatory and testing fees. On July 30, 2007, NYSE Regulation and the National Association of Securities Dealers, Inc. (“NASD”) consolidated their member regulation operations into a combined organization, FINRA. In connection with that transaction, NYSE Regulation agreed to remit to FINRA certain registration and regulatory fees that NYSE charges its member organizations. Because the regulatory activities associated with those fees are now performed by FINRA, those fees compensate FINRA for the regulatory services it assumed as a result of the regulatory consolidation. The NYSE registration and regulatory fees currently remitted to FINRA include: • Branch Office Fees, which are charged, per branch, $350.00 for the first 1,000 branches, $150.00 for the next 2,000 branches, and $125.00 for over 3,000 branches; 5 5 *See* NYSE Rule 342.11; *see also* FINRA By-Laws, Section 4(a) of Schedule A. • Registered Persons Fees, which are $65.00 for a new applicant, $43 for a transfer applicant, and $52.00 for annual maintenance, per person; 6 6 *See* NYSE Rule 345.14; *see also* FINRA By-Laws, Section 4(b) of Schedule A. • Regulation T Credit Extensions, which are $4.00 per extension; 7 7 *See* NYSE Rule 434; *see also* FINRA By-Laws, Section 8 of Schedule A. • Statutory Disqualification Filing Fee, which is $1,500; 8 8 *See* NYSE Rule 346(f); *see also* FINRA By-Laws, Section 12 of Schedule A. • Statutory Disqualification Review Fee, which is $1,000; 9 9 *See* NYSE Rule 346(f); *see also* FINRA By-Laws, Section 12 of Schedule A. • FOCUS Feedback, which is $250.00 each or $900 for four quarters; 10 10 *See* NYSE Rule 416.10. • Regulatory Element Fee, which is $75.00; 11 and 11 *See* NYSE Rule 345A; *see also* FINRA By-Laws, Section 4(f) of Schedule A. • Series 7 Qualification Exam, which is $100. 12 12 *See* NYSE Rule 345; *see also* FINRA By-Laws, Section 4(c) of Schedule A. The foregoing fees are charged under the authority of NYSE rules that have been designated as “Common Rules” under the 17d-2 Allocation Plan that NYSE entered into with FINRA. 13 FINRA has informed NYSE Regulation that it has reviewed the above-listed registration and regulatory fees and has determined to cease charging those fees effective January 1, 2008. FINRA will make a parallel filing with the Commission to reflect this determination. Accordingly, as contemplated by the 17d-2 Agreement, the NYSE is filing to amend its Price List to eliminate the above-listed fees, effective January 1, 2008. 13 Pursuant to Rule 17d-2 under Act, NYSE, NYSE Regulation, Inc., and NASD entered into an agreement to reduce regulatory duplication for firms that are members of FINRA and also members of NYSE on or after July 30, 2007, by allocating to FINRA certain regulatory responsibilities for selected NYSE rules (the “17d-2 Agreement”). The Agreement includes a list of those rules (“Common Rules”) for which FINRA has assumed regulatory responsibilities. *See* Securities Exchange Act Release No. 56148 (July 26, 2007), 72 FR 42146 (August 1, 2007) (Notice of Filing and Order Approving and Declaring Effective a Plan for the Allocation of Regulatory Responsibilities). 2. Statutory Basis The Exchange believes that the basis under the Act for this proposed rule change is the requirement under section 6(b)(5) 14 that an Exchange have rules that are designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest. 14 15 U.S.C. 78f(b)(5). B. Self-Regulatory Organization's Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others The Exchange has neither solicited nor received written comments on the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing rule change is concerned solely with the administration of the Exchange and has, therefore, become effective pursuant to section 19(b)(3)(A)(iii) of the Act 15 and Rule 19b-4(f)(3) thereunder. 16 At any time within 60 days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. 15 15 U.S.C. 78s(b)(3)(A). 16 17 CFR 240.19b-4(f)(6)(iii). IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov.* Please include File Number SR-NYSE-2007-127 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-NYSE-2007-127. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the NYSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NYSE-2007-127 and should be submitted on or before January 30, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 17 17 17 CFR 200.30-3(a)(12). Florence E. Harmon, Deputy Secretary. [FR Doc. E8-156 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57087; File No. SR-NYSEArca-2008-01] Self-Regulatory Organizations; NYSE Arca, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to the Closing Time for Options on Exchange-Traded Funds January 2, 2008. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on January 2, 2008, NYSE Arca, Inc. (“NYSE Arca” or the “Exchange”), through its wholly owned subsidiary, NYSE Arca Equities, Inc. (“NYSE Arca Equities”), filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I and II below, which Items have been substantially prepared by NYSE Arca. The Exchange filed the proposal as “non-controversial” pursuant to section 19(b)(3)(A)(iii) of the Act 3 and Rule 19b-4(f)(6) thereunder, 4 which renders it effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 15 U.S.C. 78s(b)(3)(A)(iii). 4 17 CFR 240.19b-4(f)(6). I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change NYSE Arca proposes to amend NYSE Arca Rule 7.1 in order to change the time at which certain options on exchange-traded funds (“ETFs”) cease trading on the Exchange from 1:15 p.m. Pacific Time (“PT”) to the time trading ceases in the core trading session of the primary listing exchange for the underlying security. The text of the proposed rule change is available at the Exchange's principal office, the Commission's Public Reference Room, and *http://www.nysearca.com* . II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, NYSE Arca included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant parts of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to amend NYSE Arca Rule 7.1 (“Rule”), Trading Sessions, to change the time at which certain options on ETFs cease trading on the Exchange. The rule currently specifies the trading hours for options on ETFs as commencing at 6:30 a.m. PT and ending at 1:15 p.m. PT. This extended trading time mirrored the operative closing time of the underlying ETF, which for most underlying ETFs was 1:15 p.m. PT—as set by the primary listing exchange. Recently, the Exchange submitted a proposed rule change that was effective upon filing that governs the trading hours of ETFs listed on NYSE Arca Equities. 5 As a result of that proposed rule change, the closing time for ETFs listed on NYSE Arca Equities changed from 1:15 p.m. PT to 1 p.m. PT. In order to synchronize the closing time of options on ETFs with the closing of the underlying ETF on the primary listing exchange, NYSE Arca hereby proposes to cease trading of the overlying options at the same time as the primary listing exchange closes its core trading session in the underlying ETF. 6 In the case of options on ETFs listed on NYSE Arca Equities, starting January 2, 2008, this time will be 1 p.m. PT. 5 *See* Securities Exchange Act Release No. 56888 (December 3, 2007), 72 FR 70366 (December 11, 2007) (SR-NYSEArca-2007-124). 6 As amended, this rule will mirror that of the Chicago Board Options Exchange (“CBOE”). CBOE Rule 6.1 Interpretations and Policies .01 states, in part, that “hours during which transactions in options on individual stocks may be made on the Exchange shall correspond to the normal hours for business set forth in the rules of the primary exchange listing the stocks underlying CBOE options.” The Exchange intends this system change to be effective on filing and operative on January 2, 2008. By amending this rule, the Exchange will simply synchronize the closing time for options on ETFs with the time at which the core trading session of the underlying ETF closes on the primary listing exchange. 2. Statutory Basis The proposed rule change is consistent with section 6(b) of the Act, 7 in general, and furthers the objectives of section 6(b)(5) 8 in particular in that it is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in facilitating transactions in securities, and to remove impediments to and perfect the mechanisms of a free and open market and a national market system. 7 15 U.S.C. 78f(b). 8 15 U.S.C. 78f(b)(5). B. Self-Regulatory Organization's Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others The Exchange has neither solicited nor received written comments on the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Because the foregoing proposed rule change does not:
(1)Significantly affect the protection of investors or the public interest;
(2)impose any significant burden on competition; and
(3)become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate if consistent with the protection of investors and the public interest, it has become effective pursuant to section 19(b)(3)(A) of the Act 9 and Rule 19b-4(f)(6) thereunder. 10 9 15 U.S.C. 78s(b)(3)(A). 10 17 CFR 240.19b-4(f)(6). The Exchange has requested that the Commission waive the requirement that the Exchange provide the Commission written notice of its intent to file the proposed rule change, along with a brief description and text of the proposed rule change, at least five business days prior to the date on which the Exchange filed the proposed rule change pursuant to Rule 19b-4(f)(6)(iii). The Commission hereby grants this request. NYSE Arca has requested that the Commission waive the 30-day operative delay and designate the proposed rule change to become operative on January 2, 2008. The proposal would synchronize the closing time for options on ETFs with the time at which the underlying ETF closes in the core trading session of the primary listing exchange. The Commission notes that the present proposal is similar to CBOE Rule 6.1. Therefore, the Commission designates the proposed rule change as operative on January 2, 2008. 11 11 For the purposes only of waiving the operative date of this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. *See* 15 U.S.C. 78c(f). At any time within 60 days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in the furtherance of the purposes of the Act. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov* . Please include File Number SR-NYSEArca-2008-01 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-NYSEArca-2008-01. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NYSEArca-2008-01 and should be submitted on or before January 30, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 12 12 17 CFR 200.30-3(a)(12). Florence E. Harmon, Deputy Secretary. [FR Doc. E8-135 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57086; File No. SR-Phlx-2007-90] Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto Relating to the $1 Strike Pilot Program January 2, 2008. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on December 12, 2007, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the Exchange. On December 28, 2007, the Exchange filed Amendment No. 1 to the proposed rule change. 3 The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 The Exchange states that Amendment No. 1 to the proposed rule change supersedes and replaces the original filing in its entirety. I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend Commentary .05 to Phlx Rule 1012 (Series of Options Open for Trading) to expand the $1 Strike Pilot Program (“$1 Pilot”) and to request permanent approval of the $1 Pilot. 4 The text of the proposed rule change is available at the Exchange, the Commission's Public Reference Room, and *http://www.phlx.com* . 4 The Commission approved the $1 Pilot on June 11, 2003. *See* Securities Exchange Act Release No. 48013 (June 11, 2003), 68 FR 35933 (June 17, 2003) (SR-Phlx-2002-55). The $1 Pilot has subsequently been extended through June 5, 2008. *See* Securities Exchange Act Release Nos. 49801 (June 3, 2004), 69 FR 32652 (June 10, 2004) (SR-Phlx-2004-38) (extending the $1 Pilot until June 5, 2005); 51768 (May 31, 2005), 70 FR 33250 (June 7, 2005) (SR-Phlx-2005-35) (extending the $1 Pilot until June 5, 2006); 53938 (June 5, 2006), 71 FR 34178 (June 13, 2006) (SR-Phlx-2006-36) (extending the $1 Pilot until June 5, 2007); and 55666 (April 25, 2007), 72 FR 23879 (May 1, 2007) (SR-Phlx-2007-29) (extending the $1 Pilot until June 5, 2008). The other options exchanges have similar $1 strike price listing programs that were likewise extended through June 5, 2008. II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the proposed rule change is to expand the number of options classes eligible for the $1 Pilot and to request permanent approval of the $1 Pilot and thereby provide investors with greater flexibility in the trading of equity options that overlie lower priced stocks and allow equity options positions that are better tailored to meet investment objectives. The $1 Pilot, under the terms set forth in Commentary .05 to Phlx Rule 1012, currently allows the Exchange to establish $1 strike price intervals on options classes overlying no more than five individual stocks designated by the Exchange where:
(1)The underlying stock closes below $20 on the primary market on the trading day before selection by the Exchange;
(2)the $1 strike price is from $3 to $20;
(3)the $1 strike price is no more than $5 above or below the closing price of the underlying stock on the preceding day; and
(4)the $1 strike price is not within $0.50 of an existing $2.50 strike price in the same series. The Exchange may not list long-term option series (“LEAPS”) at $1 strike price intervals for any class selected for the $1 Pilot. In addition, pursuant to the $1 Pilot, the Exchange may list $1 strike prices on any other option classes if those classes are specifically designated by other securities exchanges that employ a similar $1 strike price program under their respective rules. The Exchange proposes to expand the $1 Pilot to allow it to select a total of 10, instead of the current 5, individual stocks on which option series may be listed at $1 strike price intervals. Additionally, the Exchange proposes to expand the price range on which it may list $1 strikes to $3-$50, instead of the current $3-$20. The proposed expanded and permanent $1 Pilot would be known as the “$1 Strike Program.” The Exchange notes that the existing restrictions on listing $1 strikes would continue to apply; *i.e.* , no $1 strike price may be listed that is greater than $5 from the underlying stock's closing price in its primary market on the previous day or that would result in strike prices being $0.50 apart. As stated in the Commission order approving Phlx's $1 Pilot and in the subsequent extensions of the $1 Pilot, 5 the Exchange believes that $1 strike price intervals provide greater trading flexibility to investors so that they may better achieve their investment objectives. The Exchange states that its member firms representing customers have requested that Phlx seek to expand the $1 Pilot both in terms of the number of classes that can be selected by the Exchange and the range in which $1 strikes may be listed. 5 *See id* . Phlx's last $1 Pilot report (the “Report”) reviewed the Exchange's positive experience with the $1 Pilot. 6 The Exchange states that the Report showed the strength and efficacy of the $1 Pilot on the Exchange, as reflected by the increase in the percentage of $1 strikes in comparison to total options volume traded on Phlx at $1 strike price intervals and other options volume and the continuing robust open interest of options traded on Phlx at $1 strike price intervals. With regard to the impact on systems capacities, Phlx's analysis of the $1 Pilot showed that the impact on Phlx's, OPRA's, and market data vendors' respective automated systems has been negligible. The Exchange states that, as indicated in the Report, the $1 Pilot has not created, and in the future should not create, capacity problems for the systems of OPRA. Phlx represents that it has sufficient capacity to handle an expansion of the $1 Pilot, as proposed. 6 *See* Securities Exchange Act Release No. 55666 (April 25, 2007), 72 FR 23879 (May 1, 2007) (SR-Phlx-2007-29) (enclosing the Report as Exhibit 3 to the filing). Finally, because the $1 Pilot has been very successful in allowing investors to establish equity options positions that are better tailored to meeting their investment objectives, Phlx requests that the $1 Pilot, as expanded, be approved on a permanent basis. 2. Statutory Basis The Exchange believes that its proposal is consistent with section 6(b) of the Act, 7 in general, and furthers the objectives of section 6(b)(5), specifically, 8 in that it is designed to promote just and equitable principles of trade, to perfect the mechanism of a free and open market and the national market system, and, in general, to protect investors and the public interest. The proposal should achieve this by allowing continued listing of options at $1 strike price intervals within certain parameters, thereby stimulating customer interest in options overlying the lowest tier of stocks and creating greater trading opportunities and flexibility and providing customers with the ability to more closely tailor investment strategies to the precise movement of the underlying stocks. 7 15 U.S.C. 78f(b). 8 15 U.S.C. 78f(b)(5). B. Self-Regulatory Organization's Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others The Exchange states that no written comments on the proposed rule change were either solicited or received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the **Federal Register** or within such longer period
(i)as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or
(ii)as to which the Exchange consents, the Commission will: A. By order approve such proposed rule change, or B. Institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov* . Please include File Number SR-Phlx-2007-90 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-Phlx-2007-90. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-Phlx-2007-90 and should be submitted on or before January 30, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 9 9 17 CFR 200.30-3(a)(12). Florence E. Harmon, Deputy Secretary. [FR Doc. E8-136 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P SECURITIES AND EXCHANGE COMMISSION [Release No. 34-57090; File No. SR-Phlx-2007-94] Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Amending the Examinations Fee January 3, 2008. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on December 28, 2007, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the Exchange. The Exchange has designated this proposal as one establishing or changing a due, fee, or other charge imposed by Phlx under section 19(b)(3)(A)(ii) of the Act 3 and Rule 19b-4(f)(2) thereunder, 4 which renders the proposal effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 15 U.S.C. 78s(b)(3)(A)(ii). 4 17 CFR 240.19b-4(f)(2). I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change Phlx proposes to expand its current Examinations Fee in order to assess this fee on:
(1)Member organizations and participant organizations, 5 for whom the Exchange is the Designated Examining Authority (“DEA”), that do not employ any off-floor traders; and
(2)“inactive organizations.” While changes to the Exchange's fee schedule pursuant to this proposal are effective upon filing, the Exchange has designated that the proposed changes become operative beginning January 1, 2008. The text of the proposed rule change is available at the Exchange, on its Web site at *http:// phlx.com/exchange/phlx_rule_fil.html* , and at Commission's Public Reference Room. 5 For purposes of this proposed rule change, the term “participant organization” means Foreign Currency Options Participant Organization, as that term is defined in Section 1-1( *l* ) of Phlx's By-Laws. *See* telephone conversation between Cynthia Hoekstra, Vice President, Phlx, and Christopher Chow, Special Counsel, Division of Trading and Markets, Commission, on December 31, 2007. II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change, and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose Currently, the Exchange implements a tiered Examinations Fee based on the number of off-floor traders in the same member/participant organization for whom the Exchange is the DEA. 6 Specifically, a member/participant organization is assessed $2,100 per month for one to ten off-floor traders; $2,600 per month for 11 to 50 off-floor traders; $5,000 per month for 51 to 200 off-floor traders; and $12,500 per month for over 200 off-floor traders. However, the following member organizations are currently exempt from the assessment of the Examinations Fee:
(1)Inactive organizations; 7 and
(2)organizations operating through one or more Phlx markets that demonstrated that 25% or more of its revenue as reflected on the most recently submitted FOCUS report or transactions as reflected on its purchase and sales blotter are derived from securities transactions on the Phlx. 6 In connection with charges assessed in connection with the trading of equity securities on XLE (the Exchange's equity trading system), Sponsored Participants are not included in the calculation of the number of off-floor traders in a Sponsoring Member Organization. *See* Securities Exchange Act Release No. 54941 (December 14, 2006), 71 FR 77079 (December 22, 2006) (SR-Phlx-2006-70). 7 An inactive organization is defined as one that has no securities transaction revenue, as determined by Financial and Operational Combined Uniform Single Report (“FOCUS reports”) or other financial filings, as long as the member/participant organization continues to have no such revenue each month. The Exchange proposes to assess the Examinations Fee on those member/participant organizations who do not have any off-floor traders because the Exchange must examine those member/participant organizations for whom the Exchange is the DEA. 8 Member/ participant organizations with no off-floor traders in the same member/participant organization would be assessed a monthly fee of $2,100, which is the same fee that is currently assessed on member/participant organizations with one to ten off-floor traders. 8 Member/participant organizations that have operated without an off-floor trader generally rely on persons registered with affiliated broker-dealers or operate utilizing a “black box” trading technology. Additionally, the Exchange proposes to assess the Examinations Fee on inactive organizations, thereby eliminating the current inactive member/participant organization exemption. 9 As a result, inactive member/participant organizations for whom the Exchange is the DEA will be assessed the Examinations Fee based on the number of off-floor traders in that inactive member/participant organization. 10 9 The Exchange represents that it will continue to conduct examinations of member/participant organizations that have chosen to elect an “inactive status.” *See* telephone conversation between Cynthia Hoekstra, Vice President, Phlx, and Christopher Chow, Special Counsel, Division of Trading and Markets, Commission, on January 2, 2008. 10 Member organizations operating through one or more Phlx markets that demonstrated that 25% or more of its revenue as reflected on the most recently submitted FOCUS report or transactions as reflected on its purchase and sales blotter are derived from securities transactions on Phlx will continue to be exempt from the assessment of the Examinations Fee. The Exchange intends to implement the Examinations Fee as set forth in this proposal beginning January 1, 2008. The Exchange states that the purpose of revising the Examinations Fee is to more efficiently and effectively assess member/participant organizations for costs in connection with conducting examinations of member/participant organizations that do not have any off-floor traders for whom the Exchange is the DEA and for those that choose to elect an “inactive status.” 2. Statutory Basis The Exchange believes that the proposed rule change is consistent with the objectives of section 6 of the Act 11 in general, and furthers the objectives of section 6(b)(4) of the Act 12 in particular, in that it is designed to provide for the equitable allocation of reasonable dues, fees, and other charges among its members and other persons using its facilities. According to the Exchange, assessing member/participant organizations an Examinations Fee as set forth in this proposal should more efficiently and effectively charge those member/participant organizations for costs associated with conducting examinations of these organizations. 11 15 U.S.C. 78f(b). 12 15 U.S.C. 78f(b)(4). B. Self-Regulatory Organization's Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were either solicited or received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing proposed rule change has been designated as a fee change pursuant to section 19(b)(3)(A)(ii) of the Act 13 and Rule 19b-4(f)(2) 14 thereunder, because it establishes or changes a due, fee, or other charge imposed by the Exchange. Accordingly, the proposal took effect upon filing with the Commission. At any time within 60 days of the filing of such proposed rule change the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. 13 15 U.S.C. 78s(b)(3)(A)(ii). 14 17 CFR 240.19b-4(f)(2). IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( *http://www.sec.gov/rules/sro.shtml* ); or • Send an e-mail to *rule-comments@sec.gov.* Please include File Number SR-Phlx-2007-94 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-Phlx-2007-94. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( *http://www.sec.gov/rules/sro.shtml* ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-Phlx-2007-94 and should be submitted on or before January 30, 2008. 15 17 CFR 200.30-3(a)(12). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 15 Florence E. Harmon, Deputy Secretary. [FR Doc. E8-150 Filed 1-8-08; 8:45 am] BILLING CODE 8011-01-P DEPARTMENT OF STATE [Public Notice 6055] Privacy Act of 1974; System of Records *Summary:* Passport Services has prepared an update of its system of records notice
(SORN)as required by the Privacy Act 5 U.S.C. 552a and Appendix I to OMB Circular A-130 (“Federal Agency Responsibilities for Maintaining Records About Individuals”). Publication in the **Federal Register** of the updated SORN will establish a number of new “routine uses” for sharing passport records outside the Department of State. The purpose in granting access to other entities varies, but principally encompasses the following functions: • To support national defense, border security, and foreign policy activities; • To ensure the proper functioning and integrity of law enforcement, counterterrorism, and fraud-prevention activities by supporting law enforcement personnel in the conduct of their duties; • To support the investigatory process; and • To assist with verification of passport validity to support employment eligibility and identity corroboration for public and private employment. New routine users listed in the SORN include the Department of Homeland Security, the National Counter-Terrorism Center, the Department of Justice (including components such as the FBI), foreign governments, and entities such as Interpol, for counter-terrorism and other purposes such as border security and fraud prevention. New routine uses are not considered effective until after a 40-day period enabling review and comment by the public, OMB and Congress. SYSTEM NAME: Passport Records (STATE-26). SECURITY CLASSIFICATION: Classified and unclassified. SYSTEM LOCATION: Department of State, Passport Services, Annex 17, 1111 19th Street, NW., Washington, DC 20522-1705. CATEGORIES OF INDIVIDUALS COVERED BY THE SYSTEM: Records are maintained in the Passport Records system about individuals who:
(a)Have applied for the issuance, amendment, extension, or renewal of U.S. passport books and passport cards;
(b)Were issued U.S. passport books or cards, or had passports amended, extended, renewed, limited, revoked, or denied;
(c)Have applied to have births overseas reported as births of U.S. citizens overseas;
(d)Were issued a Consular Report of Birth Abroad of U.S. citizens or for whom Certification(s) of Birth have been issued;
(e)Applied at American Diplomatic or Consular posts for registration and have so registered;
(f)Were issued Cards of Registration and Identity as U.S. citizens;
(g)Were issued Certificates of Loss of Nationality of the United States by the Department of State;
(h)Applied at American Diplomatic or Consular Posts for issuance of Certificates of Witness to Marriage, and individuals who have been issued Certificates of Witness to Marriage;
(i)Were deceased individuals for whom a Report of Death of an American Citizen Abroad has been obtained;
(j)Although U.S. citizens, are not or may not be entitled under relevant passport laws and regulations to the issuance or possession of U.S. passport books, cards, or other documentation or service(s);
(k)Have previous passport records that must be reviewed before further action can be taken on their passport application or request for other consular services;
(l)Requested their own or another's passport records under FOIA or the Privacy Act, whether successfully or not; or
(m)Have corresponded with Passport Services concerning various aspects of the issuance or denial of a specific applicant's U.S. passport books or cards. AUTHORITY FOR MAINTENANCE OF THE SYSTEM:
(a)8 U.S.C. 1401-1503
(2007)(Acquisition and Loss of U.S. Citizenship or U.S. Nationality; Use of U.S. Passports);
(b)18 U.S.C. 911, 1001, 1541-1546
(2007)(Crimes and Criminal Procedure);
(c)22 U.S.C. 211a-218, 2651a, 2705 (2007); Executive Order 11295, August 5, 1966, 31 FR 10603; (Authority of the Secretary of State in granting and issuing U.S. passports); and
(2007)(Travel Control of Citizens). CATEGORIES OF RECORDS IN THE SYSTEM: Passport Services maintains U.S. passport records for passports issued from 1925 to the present, as well as vital records related to births abroad, deaths, and witnesses to marriages overseas. The passport records system does not maintain evidence of travel such as entrance/exit stamps, visas, or residence permits, since this information is entered into the passport book after it is issued. The passport records system includes the following categories of records: • Passport books and passport cards, applications for passport books and passport cards, and applications for additional visa pages, amendments, extensions, replacements, and/or renewals of passport books or cards (including all information and materials submitted as part of or with all such applications); • Applications for registration at American Diplomatic and Consular Posts as U.S. citizens or for issuance of Cards of Identity and Registration as U.S. Citizens; • Consular Reports of Birth Abroad of United States citizens; • Certificates of Witness to Marriage; • Certificates of Loss of United States Nationality; • Oaths of Repatriation; • Consular Certificates of Repatriation; • Reports of Death of an American Citizen Abroad; • Cards of Identity and Registration as U.S. citizens; • Lookout files which identify those persons whose applications for a consular or related service require other than routine examination or action; and • Miscellaneous materials, which are documents and/or records maintained separately, if not in the application, including but not limited to the following types of documents: ○ Investigatory reports compiled in connection with granting or denying passport and related services or prosecuting violations of passport criminal statutes; ○ Transcripts and opinions on administrative hearings, appeals and civil actions in federal courts; ○ Legal briefs, memoranda, judicial orders and opinions arising from administrative determinations relating to passports and citizenship; ○ Birth and baptismal certificates; ○ Court orders; ○ Arrest warrants; ○ Medical, personal and financial reports; ○ Affidavits; ○ Inter-agency and intra-agency memoranda, telegrams, letters, and other miscellaneous correspondence; ○ An electronic index of all passport application records created since 1978, and some passport application records created between 1962 and 1978; ○ An electronic index of Department of State Reports of Birth of American Citizens abroad; and/or ○ Records of lost and stolen passports. ROUTINE USES OF RECORDS MAINTAINED IN THE SYSTEM, INCLUDING CATEGORIES OF USERS AND PURPOSES OF SUCH USES: The information maintained in the Passport Services records is used to establish the U.S. citizenship and identity of persons for a variety of legal purposes including, but not limited to, the adjudication of passport applications and requests for related services, social security benefits, employment applications, estate settlements, and federal and state law enforcement investigations. The principal users of this information outside the Department of State include the following users: • Department of Homeland Security for border patrol, screening, and security purposes; law enforcement, counterterrorism, and fraud prevention activities; and for verification of passport validity to support employment eligibility and identity corroboration for public and private employment; • Department of Justice, including the Federal Bureau of Investigation, the Bureau of Alcohol, Tobacco, Firearms and Explosives, the U.S. Marshals Service, and other components, for law enforcement, counterterrorism, border security, fraud prevention, and criminal and civil litigation activities; • Internal Revenue Service for the current addresses of specifically identified taxpayers in connection with pending actions to collect taxes accrued, examinations, and/or other related tax activities; • INTERPOL and other international organizations for law enforcement, counterterrorism, fraud prevention, criminal activities related to lost and stolen passports; • National Counterterrorism Center to support strategic operational planning and counterterrorism intelligence activities; • Office of Personnel Management (OPM), other federal agencies, or contracted outside entities to support the investigations OPM, other federal agencies, and contractor personnel conduct for the federal government in connection with verification of employment eligibility and/or the issuance of a security clearance; • Social Security Administration to support employment-eligibility verification for public and private employers, and for support in verification of social security numbers used in processing U.S. passport applications; • Federal, state, local, or other agencies having information on an individual's history, nationality, or identity, to the extent necessary to obtain information from these agencies relevant to adjudicating an application for a passport or related service, or where there is reason to believe that an individual has applied for or is in possession of a U.S. passport fraudulently or has violated the law; • Federal, state, local or other agencies for use in legal proceedings as government counsel deems appropriate, in accordance with any understanding reached by the agency with the U.S. Department of State; • Public and private employers seeking to confirm the authenticity of the U.S. passport when it is presented as evidence of identity and eligibility to work in the United States; • Immediate families when the information is required by an individual's immediate family; • Private U.S. citizen “wardens” designated by U.S. embassies and consulates to serve, primarily in emergency and evacuation situations, as channels of communication with other U.S. citizens in the local community; • Attorneys representing an individual in administrative or judicial passport proceedings when the individual to whom the information pertains is the client of the attorney making the request; • Members of Congress when the information is requested on behalf of or at the request of the individual to whom the record pertains; • Contractor personnel conducting data entry, scanning, corrections, and modifications; • Foreign governments, to permit such governments to fulfill passport control and immigration duties and their own law enforcement, counterterrorism, and fraud prevention functions, and to support U.S. law enforcement, counterterrorism, and fraud prevention activities; and • Government agencies other than the ones listed above that have statutory or other lawful authority to maintain such information may also receive access on a need-to-know basis; however, all information is made available to users only for a previously-established routine use. Also see the “Routine Uses” paragraph of the Department of State Prefatory Statement published in the **Federal Register** . STORAGE: Hard copy, electronic media. RETRIEVABILITY: By individual name or passport book or card number. SAFEGUARDS: Passport records are protected by the Privacy Act of 1974, 5 U.S.C. 552a (2007). All employees of the Department of State have undergone a thorough background security investigation and contractors have background investigations in accordance with their contracts. Access to the Department of State and its annexes is controlled by security guards, and admission is limited to those individuals possessing a valid identification card or individuals under proper escort. Passport office annexes have security access controls (code entrances) and/or security alarm systems. All records containing personal information are maintained in secured file cabinets or in restricted areas, access to which is limited to authorized personnel. Access to computerized databases is password-protected and under the responsibility of the system manager and persons who report to him or her. The system manager has the capability of viewing and printing audit trails of access from the electronic media, thereby permitting monitoring of computer usage. RETENTION AND DISPOSAL: Retention of these records varies depending upon the specific record involved. They are retired or destroyed in accordance with published record schedules of the Department of State and as approved by the National Archives and Records Administration. More specific information may be obtained by writing to the Office of Information Programs and Services, SA-2, 555 22nd Street, NW., Washington, DC 20522. SYSTEM MANAGER AND ADDRESS: Deputy Assistant Secretary of State for Passport Services, Room 5807; Department of State; 2201 C Street, NW., Washington, DC 20520-4818. NOTIFICATION PROCEDURE: An individual seeking to determine whether Passport Services maintains records pertaining to him/her must submit a written request for notification of whether the system of records contains a record pertaining to him/her. The body of the request must state that s/he wishes the Passport Records database to be checked, and must include the following information: • Name; • Date and place of birth; • Current mailing address; • Signature, and • Passport number, if known. A request to search Passport Records, STATE-26, will be treated also as a request to search Overseas Citizens Services Records, STATE-05, when it pertains to passport, registration, citizenship, birth, or death records transferred from STATE-05 to STATE-26. Requests should be mailed to the following address: Department of State, Passport Services, Law Enforcement Liaison Division, Room 500, 1111 19th Street, NW., Washington, DC 20524-1705. Responses to such requests will consist of a letter indicating the records that exist in the passport records system. Additional information regarding applicable fees, third-party requests, certified copies, and frequently asked questions is available at *http://www.travel.state.gov/:passport/services/:copies/copies:_872:.html* . RECORD ACCESS AND AMENDMENT PROCEDURES: Individuals who wish to gain access to or amend records pertaining to themselves or their minor children should write to the appropriate address listed below. There are several ways individuals may gain access to or amend passport records pertaining to themselves or their minor children. First, individuals may request access to records in his/her name and the records of any minor children under the Privacy Act of 1974. 5 U.S.C. 552a (2007). Alternatively, third parties may request access to records under the guidelines of the Freedom of Information Act, 5 U.S.C. 552 (2007). Additionally, individuals may request access to their passport and/or vital records through the applicable Passport Office request process, as described below. Access may be granted to third parties to the extent provided for under applicable laws and regulations. Please refer to *http://www.travel.state.gov* for detailed information regarding applicable fees, third-party requests, certified copies, and frequently asked questions. The appropriate methods by which passport records and vital records may be requested are as follows: I. Privacy Act of 1974 and Freedom of Information Act Under the Privacy Act of 1974, individuals have the right to request access to his or her records at no charge, and to request that the Department of State amend any such records that s/he believes are not accurate, relevant, timely, or complete. 5 U.S.C. 552a(d)(3) (2007). Additionally, third parties may request passport and vital records information from 1925 to the present, within the guidelines of the Privacy Act and the Freedom of Information Act, 5 U.S.C. 552 (2007). Written requests for access to or amendment of records must comply with the Department's regulations published at 22 CFR part 171. In accordance with 22 CFR 171.32 and 171.33, amendment requests must include the following information: • Verification of personal identity (including full name, current address, and date and place of birth), either notarized or submitted under penalty of perjury; • Any additional information if it would be needed to locate the record at issue; • A description of the specific correction requested; • An explanation of why the existing record is not accurate, relevant, timely, or complete; and • Any available documents, arguments, or other data to support the request. Requests under the Privacy Act and/or the Freedom of Information Act must be made in writing to the following office: Office of Information Programs and Services, U.S. Department of State, SA-2, Room 8100, 515 22nd Street, NW., Washington, DC 20522-8100. II. Access to Records through the Passport Office Request Process A. Passport Records *1. 1925 to the Present* Individuals must submit a typed or clearly printed, notarized request that provides the following information to request passport records for themselves and/or their minor children: • Full name at birth and any subsequent name changes, and/or the full name of any minor child or children, if requesting their records; • Date and place of birth, and/or date and place of birth for any minor child or children; • Current mailing address; • Current daytime telephone number; • Current e-mail address, if available; • Reason for the request; • Dates or estimated dates the passport was issued; • Passport numbers or any other information that will help locate the records; and • A copy of the requestor's valid photo identification. All requests for passport records issued from 1925 to the present should be mailed to the following address: Department of State, Passport Services, Law Enforcement Liaison Division, Room 500, 1111 19th Street, NW., Washington, DC 20524-1705. *2. Prior to 1925* The National Archives and Records Administration maintains records for passport issuances prior to 1925, which may be requested by writing to the following address: National Archives and Records Administration, Archives 1, Reference Branch, 8th & Pennsylvania Ave., NW., Washington, DC. B. Vital Records—Certificates of Birth Abroad, Report of Death, Certificate of Witness to Marriage, and Certification of No Record Submit a signed and notarized written request including all pertinent facts of the occasion along with a copy of the requester's valid photo identification. Only the subject, parent, or legal guardian may request a birth record. The following information must be included in the request: *General Background Information* • Date of request. • Purpose of request. • Document Requesting (Certificate of Birth, Report of Death, Certificate of Witness of Marriage (prior to 1985), or Certification of No Record). • Number of documents requesting. • Current mailing address and daytime telephone number. *Facts of Birth, Death, or Marriage* • Name (at birth/death/marriage). • Name after adoption (if applicable). • Date of birth/death/marriage. • Country of birth/death/marriage. • Father's name. • Father's date and place (state/country) of birth. • Mother's name. • Mother's date and place (state/country) of birth. *Previous Passport Information* • Passport used to first enter the U.S. (if applicable). • Name of bearer. • Date of issuance. • Passport number. • Date of inclusion (if applicable, and if passport was not issued to the subject). *Current Passport Information* • Name of bearer. • Date of issuance. • Passport number. If requesting an amendment or correction to a Consular Report of Birth Abroad, please include certified copies of all documents appropriate for effecting the change (i.e., foreign birth certificate, marriage certificate, court ordered adoption or name change, birth certificates of adopting or legitimating parents, etc.). The original or replacement FS-240, or a notarized affidavit concerning its whereabouts also must be included. All requests for vital records through the Passport Office request process should be mailed to the following address: U.S. Department of State, Passport Services, Vital Records Section, 1111 19th Street, NW., Suite 510, Washington, DC 20522-1705. RECORD SOURCE CATEGORIES: These records contain information obtained primarily from the individual who is the subject of these records; law enforcement agencies; investigative intelligence sources, investigative security sources; and officials of foreign governments. SYSTEMS EXEMPTED FROM CERTAIN PROVISIONS OF THE ACT: Certain records contained within this system of records may be exempt from the requirements of the Privacy Act when it is necessary to: • Protect material required to be kept secret in the interest of national defense and foreign policy; • Prevent individuals that are the subject of investigation from frustrating the investigatory process, to ensure the proper functioning and integrity of law enforcement activities, to prevent disclosure of investigative techniques, to maintain the confidence of foreign governments in the integrity of the procedures under which privileged or confidential information may be provided, and to fulfill commitments made to sources to protect their identities and the confidentiality of information and to avoid endangering these sources and law enforcement personnel; or • Preclude impairment of the Department's effective performance in carrying out its lawful protective responsibilities under 18 U.S.C. 3056 and 22 U.S.C. 4802. Records meeting any of the above criteria are exempt from the following subsections of 5 U.S.C. 552a(c)(3), (d), (e)(1), (e)(4)(G), (e)(4)(H), (e)(4)(I), and
(f)(2007). See 22 CFR 171.36(b)(1), (b)(2), and (b)(3) (2007). Dated: December 31, 2007. Maura Harty, Assistant Secretary for the Bureau of Consular Affairs, Department of State. [FR Doc. E8-202 Filed 1-8-08; 8:45 am] BILLING CODE 4710-06-P DEPARTMENT OF STATE [Public Notice 6056] Privacy Act of 1974; System of Records *Summary:* This report is submitted in compliance with Appendix I to OMB Circular Number A-130 entitled “Federal Agency Responsibilities for Maintaining Records about Individuals.” The Department of State (“Department”) intends to alter an existing system of records, “Passport Records” (STATE-26), to reflect additional routine uses for the information maintained in the Passport Records System. *Purpose:* The information collected and maintained in the system of records entitled “Passport Records” is in keeping with the Department's responsibility to adjudicate applications for U.S. passports. Proposed alterations appear in the routine uses section of the system description. The purpose in granting access to other entities varies, but principally encompasses the following functions: • To support national defense, border security, and foreign policy activities; • To ensure the proper functioning and integrity of law enforcement, counterterrorism, and fraud-prevention activities by supporting law enforcement personnel in the conduct of their duties; • To support the investigatory process; and • To assist with verification of passport validity to support employment eligibility and identity corroboration for public and private employment. This Systems of Records Notice
(SORN)documents an updated list of routine uses for records maintained in the passport records system to include disclosure to the following entities: • Department of Homeland Security for law enforcement; counterterrorism; border patrol, screening, and security purposes; fraud prevention activities; and verification of passport validity to support employment eligibility and identity corroboration for public and private employment; • Department of Justice, including the Federal Bureau of Investigation, the Bureau of Alcohol, Tobacco, Firearms, and Explosives, the U.S. Marshals Service, and other components, for law enforcement, counterterrorism, border security, fraud prevention, and criminal and civil litigation activities; • INTERPOL and other international organizations for law enforcement, counterterrorism, fraud prevention, criminal activities related to lost and stolen passports; • National Counterterrorism Center to support strategic operational planning and counterterrorism intelligence activities; • Office of Personnel Management (OPM), other federal agencies, or contracted outside entities to support the investigations that OPM, other federal agencies, and contractor personnel conduct for the federal government in connection with verification of employment eligibility and/or the issuance of a security clearance; • Social Security Administration to support employment-eligibility verification for public and private employers, and for support in verification of social security numbers used in processing U.S. passport applications; • Federal, state, local or other agencies for use in legal proceedings as government counsel deems appropriate, in accordance with any understanding reached by the agency with the U.S. Department of State. • Foreign governments, to permit such governments to fulfill passport control and immigration duties and their own law enforcement, counterterrorism, and fraud prevention functions, and to support U.S. law enforcement, counterterrorism, and fraud prevention activities. • Public and private employers seeking to confirm the authenticity of the U.S. passport when it is presented as evidence of identity and eligibility to work in the United States; • Contractor personnel conducting data entry, scanning, corrections, and modifications, or conducting other authorized functions related to passport records. Authority: The authority for maintaining this system is derived from the Secretary of State's authorities with respect to the following provisions: Granting and Issuing U.S. Passports, 22 U.S.C. 211a-218, 2651a, 2705 (2007), and Executive Order 11295, August 5, 1966, 31 FR 10603; the Acquisition and Loss of U.S. Citizenship or U.S. Nationality, 8 U.S.C. 1401-1503 (2007); Travel Control of Citizens, 8 U.S.C. 1185 (2007); and Crimes and Criminal Procedure connected to U.S. Passport Applications and Use, 18 U.S.C. 911, 1001, and 1541-1546 (2007). *Impact on Privacy:* The information collected and maintained in the system of records is necessary to accomplish the Department's mission as stated above. The Department believes the system offers suitably rigorous protection of privacy under the Privacy Act to the individuals covered by the system of records. Each of the above users either has been granted access to the passport database, or has been given passport information taken from the database, in order to facilitate these entities as they address issues and problems of a legal, investigative, technical, or procedural nature that may arise pursuant to an application for or any use of a U.S. passport. In granting access or providing information from the passport database to a routine user, the Department takes appropriate steps to limit disclosure to only the specific data elements required by each routine user in the performance of its mission, not all items of information that the Department maintains about an individual. To this end, the Department has established varying levels of access that are tailored to release the minimum amount of data necessary to support the attendant routine use. Prior to granting access to the passport system of records for a proposed routine use, partner agencies generally enter into a Memorandum of Understanding
(MOU)with the Department that establishes the parameters that guide and limit the use. In addition, these MOUs establish the partner agency's responsibilities in relation to the information provided, including proper training, establishing that each user has been cleared to access the sensitive information contained in the passport records system, and ensuring that password-protected access is appropriately safeguarded by users and the agency alike. Moreover, every user who is granted access to the system is subject to remote monitoring to ensure that s/he is accessing the system for the limited, routine use that has been prescribed in advance for each user. The overall impact on privacy is thereby minimized since each user may only access an individual's information in relation to a concrete, pre-determined purpose that has been authorized by Congress and/or established by a formal, written agreement with the Department. The Department ultimately retains control of the Passport Records System and is able to appropriately limit the amount and type of information each user is able to access. Furthermore, the responsibility and accountability for all users rests with the Directorate of Passport Services. Therefore, access and control of the Passport Records system remains within the Department to allow for appropriate internal checks and balances over all users, whether in the Department of State or at partner entities. Deviations from the predetermined routine uses are not permitted, and employees may be subject to sanctions for mishandling Privacy Act-protected information. *Safeguards:* Access to the Department of State building and the annexes containing this system of records is controlled by security guards, and admission is limited to those individuals possessing a valid identification card or individuals under proper escort. These records are maintained in secured file cabinets, computer media, and/or in restricted areas, access to which is limited to authorized personnel. The computerized files are password-protected and under the direct supervision of a system manager who can monitor and audit trails of access. The system manager has the capability of printing audit trails of access from the computer media, thereby permitting regular and ad hoc monitoring of computer usage. In addition, the system logs all search and query activities conducted by users, and submits notification alerts to certifying authorities and system administrators if any unusual activity occurs. Any unusual system access patterns by non-Department users are logged and may result in suspension or termination of an individual user's or an agency's access rights. In addition, all Department employees have undergone a thorough background investigation prior to their employment. Department employees with access to the passport system are also required to undergo initial training in proper handling of this sensitive data, as well as in the correct method to maintain the security of the passport records system. All Department employees must also engage in refresher training at least annually on basic cyber security awareness, as well as training in any new security protections that may be added. As described above, partner entities also agree to provide initial and updated security training to all users who have any form of access to the passport system. Additional safeguards regarding access to the Department and its annexes are stated in the system description. *Compatibility:* The routine uses indicated are necessary for the recipients of information from the Passport Services Office to carry out their responsibilities for dealing with issues and problems of a legal, investigative, technical, or procedural nature that may arise pursuant to an application for or any use of a U.S. passport. The Department collects data on individual passport applicants in order to establish an individual's unique identity and citizenship for passport issuance. This not only enables the Department to issue passports to qualified U.S. citizens and nationals, but it also facilitates the international travel of millions of passport holders by minimizing potential fraud in the application process, which in turn increases the value and functionality of the U.S. passport as a travel and identification document. Moreover, this database enables the Department to further support the Secure Border, Open Doors initiative by assisting border patrol officers to efficiently process returning U.S. passport holders whose identities are clearly established by their passport document, which in turn is validated by the passport records system. The routine uses listed above are functionally equivalent to the original purpose of data collection. Passport Services gathers data in order to establish a sound basis to establish and document an individual's unique identity. The proposed routine users listed above likewise must establish an individual's identity in order to carry out their critical missions, which range from law enforcement, to border security, to verification of potential employment eligibility. For example, the U.S. passport is an I-9-listed Employment Eligibility Verification document that may be presented as proof of employment eligibility; thus, data disclosure to corroborate the passport's validity is compatible with the original purpose of collection. Additionally, Passport Services has worked to make the U.S. passport an internationally recognized, premier travel document. Of those entities listed above, many carry out travel-related functions that are compatible with the Passport Services mission and, thus, the original purpose of the data collection. Without adequate information and documentation, these entities would be unable or less able to ascertain whether the individual seeking entry into the United States or using the passport for overseas travel, is in fact the individual s/he claims to be. The passport records system provides a database of information that has already been well-scrutinized and evaluated by Department employees who are trained in fraud detection. Access to this thoroughly inspected database will aid the above-listed routine users as they seek to accomplish their functions. Additionally, providing other agencies the ability to confirm an individual's unique identity supports national defense, border security, and foreign policy activities, and ensures the integrity of law enforcement, counterterrorism, and fraud-prevention activities. Dated: December 31, 2007. Maura Harty, Assistant Secretary for the Bureau of Consular Affairs, Department of State. [FR Doc. E8-203 Filed 1-8-08; 8:45 am] BILLING CODE 4710-06-P DEPARTMENT OF TRANSPORTATION Federal Aviation Administration [Summary Notice No. PE-2007-48] Petition for Exemption; Summary of Petition Received; Correction AGENCY: Federal Aviation Administration (FAA), DOT. ACTION: Notice of petition for exemption received; correction. SUMMARY: This notice contains a corrected summary of a petition seeking relief from specified requirements of 14 CFR. The purpose of this notice is to improve the public's awareness of, and participation in, this aspect of FAA's regulatory activities. Neither publication of this notice nor the inclusion or omission of information in the summary is intended to affect the legal status of the petition or its final disposition. DATES: Comments on this petition must identify the petition docket number involved and must be received on or before January 29, 2008. ADDRESSES: You may send comments identified by Docket Number FAA-2007-0383 using any of the following methods: • *Government-wide rulemaking Web site:* Go to *http://www.regulations.gov* and follow the instructions for sending your comments electronically. • *Mail:* Send comments to the Docket Management Facility; U.S. Department of Transportation, 1200 New Jersey Avenue, SE., West Building Ground Floor, Room W12-140, Washington, DC 20590. • *Fax:* Fax comments to the Docket Management Facility at 202-493-2251. • *Hand Delivery:* Bring comments to the Docket Management Facility in Room W12-140 of the West Building Ground Floor at 1200 New Jersey Avenue, SE., Washington, DC, between 9 a.m. and 5 p.m., Monday through Friday, except Federal holidays. *Privacy:* We will post all comments we receive, without change, to *http://www.regulations.gov,* including any personal information you provide. Using the search function of our docket web site, anyone can find and read the comments received into any of our dockets, including the name of the individual sending the comment (or signing the comment for an association, business, labor union, etc.). You may review DOT's complete Privacy Act Statement in the **Federal Register** published on April 11, 2000 (65 FR 19477-78). *Docket:* To read background documents or comments received, go to *http://www.regulations.gov* at any time or to the Docket Management Facility in Room W12-140 of the West Building Ground Floor at 1200 New Jersey Avenue, SE., Washington, DC, between 9 a.m. and 5 p.m., Monday through Friday, except Federal holidays. FOR FURTHER INFORMATION CONTACT: Tyneka Thomas
(202)267-7626 or Frances Shaver
(202)267-9681, Office of Rulemaking, Federal Aviation Administration, 800 Independence Avenue, SW., Washington, DC 20591. SUPPLEMENTARY INFORMATION: This is a corrected summary of petition that was published on December 28, 2007. This notice is published pursuant to 14 CFR 11.85. Issued in Washington, DC, on January 3, 2008. Pamela Hamilton-Powell, Director, Office of Rulemaking. Petition for Exemption *Docket No.:* FAA-2007-0383. *Petitioner:* Ameriflight, LLC. *Section of 14 CFR Affected:* 14 CFR 61.51(f)(2). *Description of Relief Sought:* To permit Ameriflight pilots to log second in command
(SIC)flight time in aircraft types for which an SIC is not required by their type certification in specific circumstances and provided certain pilot certification, training, and checking requirements are met. [FR Doc. E8-149 Filed 1-8-08; 8:45 am] BILLING CODE 4910-13-P DEPARTMENT OF TRANSPORTATION Federal Highway Administration Environmental Impact Statement: Charleston County, SC AGENCY: Federal Highway Administration (FHWA), USDOT. ACTION: Notice of Intent. SUMMARY: The FHWA is issuing this notice to advise the public that an environmental impact statement will be prepared for a proposed highway project in Charleston County, South Carolina. FOR FURTHER INFORMATION CONTACT: Mr. Robert Lee, Division Administrator, Federal Highway Administration, 1835 Assembly Street, Suite 1270, Columbia, South Carolina 29201, Telephone: 803.765.5411, E-mail: *bob.lee@fhwa.dot.gov* . SUPPLEMENTARY INFORMATION: The FHWA, in cooperation with the South Carolina Department of Transportation (SCDOT) and Charleston County will prepare an environmental impact statement
(EIS)on a proposed Mark Clark Expressway (I-526) located in Charleston County, South Carolina. The U.S. Army Corps of Engineers will serve as a cooperating agency in developing the EIS. Completing I-526 (Mark Clark Expressway) would improve mobility in the areas by serving the anticipated future traffic growth. The Interstate 526 extension project is approximately 7.1 miles long beginning at U.S. 17 (Savannah Highway) and terminating at SC 171 (Folly Road). The FHWA and SCDOT are seeking input as a part of the scoping process to assist in identifying issues relative to this project. Letters describing the proposed action and soliciting comments will be sent to appropriate Federal, State, and local agencies, and to private organizations and citizens who have previously expressed or are known to have interest in this proposal. A formal public scoping meeting will be held between February and March 2008. A public meeting will be held between September and October 2008. In addition, a public hearing will be held after the approval of the Draft Environmental Impact Statement (DEIS). Public notice will be given indicating the time and place of the meetings and hearing. The DEIS will be available for public and agency review and comment prior to the public hearing. To ensure that the full range of issues related to this proposed action are addressed and all significant issues identified, comments, and suggestions are invited from all interested parties. Comments or questions concerning this proposed action and the EIS should be directed to the FHWA at the address provided above. (Catalog of Federal Domestic Assistance Program Number 20.205, Highway Planning and Construction. The regulations implementing Executive Order 12372 regarding intergovernmental consultation on Federal programs and activities apply to this program). Issued on January 3, 2008. Robert Lee, Division Administrator, Columbia, South Carolina. [FR Doc. E8-246 Filed 1-8-08; 8:45 am] BILLING CODE 4910-22-P DEPARTMENT OF TRANSPORTATION National Highway Traffic Safety Administration [U.S. DOT Docket Number NHTSA-2008-0001] Reports, Forms, and Recordkeeping Requirements AGENCY: National Highway Traffic Safety Administration (NHTSA), Department of Transportation. ACTION: Request for public comment on proposed collection of information. SUMMARY: Before a Federal agency can collect certain information from the public, it must receive approval from the Office of Management and Budget (OMB). Under procedures established by the Paperwork Reduction Act of 1995, before seeking OMB approval, Federal agencies must solicit public comment on proposed collections of information, including extensions and reinstatement of previously approved collections. This document describes two collections of information for which NHTSA intends to seek OMB approval. DATES: Comments must be received on or before March 10, 2008. ADDRESSES: You may submit comments [identified by DOT Docket No. NHTSA-2008-0001] to: Docket Management Facility, U.S. Department of Transportation, 1200 New Jersey Avenue, SE., West Building Ground Floor, Room W12-140, Washington, DC 20590-0001. Alternatively, you may submit your comments electronically by logging onto the Docket Management System
(DMS)Web site at *http://dms.dot.gov* . Click on “Help” to view instructions for filing your comments electronically. Regardless of how you submit your comments, you should identify the Docket number of this document. You may call the docket at
(202)647-5527. Docket hours are 9 a.m. to 5 p.m., Monday through Friday, except Federal holidays. *Instructions:* All submissions must include the agency name and docket number for this proposed collection of information. Note that all comments received will be posted without change to *http://www.regulations.gov,* including any personal information provided. Please see the Privacy Act heading below. *Privacy Act:* Anyone is able to search the electronic form of all comments received into any of our dockets by the name of the individual submitting the comment (or signing the comment, if submitted on behalf of an association, business, labor union, etc.). You may review DOT's complete Privacy Act Statement in the **Federal Register** published on April 11, 2000 (65 FR 19477-78) or you may visit *http://DocketInfo.dot.gov* . *Docket:* For access to the docket to read background documents or comments received, go to *http://www.regulations.gov* , or the street address listed above. Follow the online instructions for accessing the dockets. FOR FURTHER INFORMATION CONTACT: Complete copies of each request for collection of information may be obtained at no charge from Susan Ryan, NHTSA, 1200 New Jersey Avenue, SE., W46-310, NTI-200, Washington, DC 20590. Ms. Ryan's telephone number is
(202)366-2715. Please identify the relevant collection of information by referring to its OMB Control Number. SUPPLEMENTARY INFORMATION: Under the Paperwork Reduction Act of 1995, before an agency submits a proposed collection of information to OMB for approval, it must first publish a document in the **Federal Register** providing a 60-day comment period and otherwise consult with members of the public and affected agencies concerning each proposed collection of information. The OMB has promulgated regulations describing what must be included in such a document. Under OMB's regulation (at 5 CFR 1320.8(d)), an agency must ask for public comment on the following:
(i)Whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility;
(ii)the accuracy of the agency's estimate of the burden of the proposed collection of information, including the validity of the methodology and assumptions used;
(iii)how to enhance the quality, utility, and clarity of the information to be collected;
(iv)how to minimize the burden of the collection of information on those who are to respond, including the use of appropriate automated, electronic, mechanical, or other technological collection techniques or other forms of information technology, e.g. permitting electronic submission of responses. In compliance with these requirements, NHTSA asks for public comments on the following proposed collections of information:
(1)*Title:* Highway Safety Program Cost Summary. *OMB Control Number:* 2127-0003. *Affected Public:* 50 States, District of Columbia, Puerto Rico, U.S. Territories, and Tribal Government. *Form Number:* HS-217 Highway Safety Program Cost Summary. *Abstract:* The Highway Safety Plan identifies State's traffic safety problems and describes the program and projects to address those problems. In order to account for funds expended, States are required to submit a HS-217 Highway Safety Program Cost Summary. The Program Cost Summary is completed to reflect the state's proposed allocations of funds (including carry-forward funds) by program area, based on the projects and activities identified in the Highway Safety Plan. *Estimated Annual Burden:* 570. *Number of Respondents:* 57.
(2)*Title:* 23 CFR, part 1345, Occupant Protection Incentive Grant—Section 405. *OMB Control Number:* 2127-0600. *Affected Public:* 50 States, District of Columbia, Puerto Rico, and U.S. Territories. *Form Number:* N/A. *Abstract:* An occupant protection incentive grant is available to states that can demonstrate compliance with at least four of six criteria. Demonstration of compliance requires submission of copies of relevant seat belt and child passenger protection statutes, plan and/or reports on statewide seatbelt enforcement and child seat education programs and possibly some traffic court records. *Estimated Annual Burden:* 780. *Number of Respondents:* 56. Comments are invited on: whether the proposed collections of information are necessary for the proper performance of the functions of the Department, including whether the information will have practical utility; the accuracy of the Department's estimate of the burden of the proposed information collection; ways to enhance the quality, utility and clarity of the information to be collected; and ways to minimize the burden of the collection of information on respondents, including the use of automated collection techniques or other forms of information technology. Marlene Markison, Associate Administrator for Regional Operations and Program Delivery. [FR Doc. E8-183 Filed 1-8-08; 8:45 am] BILLING CODE 4910-59-P DEPARTMENT OF THE TREASURY Internal Revenue Service Privacy Act of 1974, as Amended AGENCY: Internal Revenue Service, Treasury. ACTION: Notice of Proposed New Privacy Act System of Records. SUMMARY: In accordance with the requirements of the Privacy Act of 1974, as amended, 5 U.S.C. 552a, the Department of the Treasury, Internal Revenue Service, gives notice of a proposed new system of records entitled “Whistleblower Office Records—Treasury/IRS 42.005.” DATES: Comments must be received no later than February 8, 2008. This new system of records will be effective February 19, 2008 unless the IRS receives comments that would result in a contrary determination. ADDRESSES: Comments should be sent to the Director, Whistleblower Office, SE:WO, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224. Comments will be available for inspection and copying in the Freedom of Information Reading Room (Room 1621), at the above address. The telephone number for the Reading Room is
(202)622-5164. FOR FURTHER INFORMATION CONTACT: Director, Whistleblower Office, SE:WO, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224. SUPPLEMENTARY INFORMATION: The proposed system will allow the IRS to maintain records pertinent to determining claimants' eligibility for and amount of awards pursuant to 26 U.S.C. 7623. The Whistleblower Office was created by section 406 of the Tax Relief and Health Care Act of 2006. Prior to its amendment by Section 406, 26 U.S.C. 7623 authorized the IRS to pay awards to claimants who provided information that led to the collection of taxes. The IRS maintained a decentralized procedure for processing requests for such awards. Section 406 amended 26 U.S.C. 7623 to establish criteria for the payment of certain awards, and to provide a judicial remedy in the U.S. Tax Court for review of these award determinations. Section 406 of the Act amends section 7623 of the Internal Revenue Code concerning the payment of awards to certain claimants denominated as “whistleblowers.” New section 7623(b) provides an award floor based on information regarding tax law violations provided by these claimants. Claimants are eligible for section 7623(b) awards based on the amount collected as a result of any administrative or judicial actions resulting from the information provided. The Whistleblower Office has responsibility for the administration of a whistleblower program, and the Secretary is required to provide an annual report to Congress on the use of section 7623. Records pertaining to award applications filed prior to the creation of the Whistleblower Office, for which an award has not yet been determined, will also be maintained in this system of records. An exemption rule is being published separately under the rules section of the **Federal Register** . The report of a new system of records, as required by 5 U.S.C. 552a(r) of the Privacy Act, has been submitted to the Committee on Government Reform of the House of Representatives, the Committee on Homeland Security and Governmental Affairs of the Senate, and the Office of Management and Budget, pursuant to Appendix I to OMB Circular A-130, “Federal Agency Responsibilities for Maintaining Records About Individuals,” dated November 30, 2000. The proposed new system of records entitled “Treasury/IRS 42.005—Whistleblower Office Records” is published in its entirety below. Dated: December 21, 2007. Peter B. McCarthy, Assistant Secretary for Management and Chief Financial Officer. TREASURY/IRS 42.005 SYSTEM NAME: Whistleblower Office Records. SYSTEM LOCATION: Whistleblower Office, Washington, DC, and Ogden Campus, Ogden, Utah. CATEGORIES OF INDIVIDUALS COVERED BY THE SYSTEM: These records include information about individuals who submit allegations of possible tax noncompliance and claims for award to the Whistleblower Office (“claimants”), claimants' representatives, and the taxpayers and third parties about whom the information is received, which is pertinent to a claim for award. CATEGORIES OF RECORDS IN THE SYSTEM: These records include claimant identity information, allegation information received, claims for award (including supporting information or documentation), information pertaining to any civil or criminal investigation initiated, or expanded, as a result of the allegations received by the Whistleblower Office, any other information pertinent to the Whistleblower Office's determination as to the amount, if any, of any award for which the claimant may be eligible under 26 U.S.C. 7623, including information pertaining to appeals of award determinations to the Tax Court (including the results of such appeals). AUTHORITY FOR MAINTENANCE OF THE SYSTEM: 26 U.S.C. 7623 and 7801, and 5 U.S.C. 301. PURPOSE(S): The records in this system will be used to administer the claimant award program under 26 U.S.C. 7623. ROUTINE USES OF RECORDS MAINTAINED IN THE SYSTEM INCLUDING CATEGORIES OF USERS AND PURPOSES OF SUCH USES: Disclosure of returns and return information may be made only as provided by 26 U.S.C. 6103. To the extent authorized by 26 U.S.C. 6103, disclosure may also be made to appropriate agencies, entities, and persons when
(1)the Department suspects or has confirmed that the security or confidentiality of information in the system of records has been compromised;
(2)the Department has determined that as a result of the suspected or confirmed compromise there is a risk of harm to economic or property interests, identity theft or fraud, or harm to the security or integrity of this system or other systems or programs (whether maintained by the Department or another agency or entity) that rely upon the compromised information; and
(3)the disclosure made to such agencies, entities, and persons is reasonably necessary to assist in connection with the Department's efforts to respond to the suspected or confirmed compromise and prevent, minimize, or remedy such harm. POLICIES AND PRACTICES FOR STORING, RETRIEVING, ACCESSING, RETAINING AND DISPOSING OF RECORDS IN THE SYSTEM: STORAGE: Paper records and electronic media. RETRIEVABILITY: Data is retrieved by the name or taxpayer identification number of the claimant(s), of the taxpayer(s) who are the subject(s) of the allegation(s), or of third parties identified in the records; the name or Centralized Authorization File
(CAF)number of the claimant's representative; or an award claim number assigned by the Whistleblower Office. SAFEGUARDS: Only persons authorized by law will have access to these records. Access controls are not less than those published in IRM 10.8.1, Information Technology
(IT)Security Policy and Standards and IRM 1.16, Physical Security Program. RETENTION AND DISPOSAL: Records are maintained in accordance with IRM 1.15.23, Records Control Schedule for Tax Administration—Examination; Item 13, Reward Claim Cases. SYSTEM MANAGER(S) AND ADDRESS: Director, Whistleblower Office, SE:WO, 1111 Constitution Avenue, NW., Washington, DC 20224. NOTIFICATION PROCEDURE: This system may not be accessed for purposes of determining whether the system contains a record pertaining to a particular individual; the records are exempt under 5 U.S.C. 552a(k)(2). RECORDS ACCESS PROCEDURES: This system may not be accessed for purposes of inspection or to contest the content of records; the records are exempt under 5 U.S.C. 552a(k)(2). CONTESTING RECORDS PROCEDURES: 26 U.S.C. 7852(e) prohibits Privacy Act amendment of tax records. RECORDS SOURCE CATEGORIES: Claimants and their representatives; Department of the Treasury employees and records; newspapers, court records, and other publicly available information. EXEMPTIONS CLAIMED FOR THE SYSTEM: This system has been designated as exempt from sections (c)(3), (d)(1)-(4), (e)(1), (e)(4)(G)-(I), and
(f)of the Privacy Act pursuant to 5 U.S.C. 552a(k)(2). See 31 CFR 1.36. [FR Doc. E8-129 Filed 1-8-08; 8:45 am] BILLING CODE 4830-01-P DEPARTMENT OF THE TREASURY Bureau of the Public Debt Proposed Collection: Comment Request ACTION: Notice and request for comments. SUMMARY: The Department of the Treasury, as part of its continuing effort to reduce paperwork and respondent burden, invites the general public and other Federal agencies to take this opportunity to comment on proposed and/or continuing information collections, as required by the Paperwork Reduction Act of 1995, Public Law 104-13 (44 U.S.C. 3506(c)(2)(A)). Currently the Bureau of the Public Debt within the Department of the Treasury is soliciting comments concerning the Stop Payment/Replacement Check Request. DATES: Written comments should be received on or before March 12, 2008, to be assured of consideration. 200 Third Street, Avery 4-A, Parkersburg, WV 26106-5312, or e-mail to *Brian.Lallemont@bpd.treas.gov.* FOR FURTHER INFORMATION CONTACT: Requests for additional information or copies of the form and instructions should be directed to Brian Lallemont, Bureau of the Public Debt, 200 Third Street, Avery 4-A, Parkersburg, WV 26106-5312,
(304)480-8108. SUPPLEMENTARY INFORMATION: *Title:* Stop Payment/Replacement Check Request. *OMB Number:* 1535-0070. *Form Number:* PD F 5192. *Abstract:* The information is requested to place a stop payment on a Treasury Direct check and request a replacement check. *Current Actions:* None. *Type of Review:* Extension. *Affected Public:* Individuals or households. *Estimated Number of Respondents:* 500. *Estimated Time per Respondent:* 15 minutes. *Estimated Total Annual Burden Hours:* 125. *Request for Comments:* Comments submitted in response to this notice will be summarized and/or included in the request for OMB approval. All comments will become a matter of public record. Comments are invited on:
(a)Whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility;
(b)the accuracy of the agency's estimate of the burden of the collection of information;
(c)ways to enhance quality, utility, and clarity of the information to be collected;
(d)ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and
(e)estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information. Dated: January 3, 2008. Brian Lallemont, Records Management Program Manager. [FR Doc. E8-242 Filed 1-8-08; 8:45 am] BILLING CODE 4810-39-P DEPARTMENT OF THE TREASURY Bureau of the Public Debt Proposed Collection: Comment Request ACTION: Notice and request for comments. SUMMARY: The Department of the Treasury, as part of its continuing effort to reduce paperwork and respondent burden, invites the general public and other Federal agencies to take this opportunity to comment on proposed and/or continuing information collections, as required by the Paperwork Reduction Act of 1995, Public Law 104-13 (44 U.S.C. 3506(c)(2)(A)). Currently the Bureau of the Public Debt within the Department of the Treasury is soliciting comments concerning the Special Form of Assignment for U.S. Registered Definitive Securities. DATES: Written comments should be received on or before March 12, 2008 to be assured of consideration. ADDRESSES: Direct all written comments to Bureau of the Public Debt, Brian Lallemont, 200 Third Street, Avery 4-A, Parkersburg, WV 26106-5312, or e-mail to *Brian.Lallemont@bpd.treas.gov* . FOR FURTHER INFORMATION CONTACT: Requests for additional information or copies of the form and instructions should be directed to Brian Lallemont, Bureau of the Public Debt, 200 Third Street, Avery 4-A, Parkersburg, WV 26106-5312,
(304)480-8108. SUPPLEMENTARY INFORMATION: *Title:* Special Form of Assignment for U.S. Registered Securities. *OMB Number:* 1535-0059. *Form Number:* PD F 1832. *Abstract:* The information is requested to complete transaction involving the assignment of U.S. Registered and Bearer Securities. *Current Actions:* None. *Type of Review:* Extension. *Affected Public:* Individuals or households. *Estimated Number of Respondents:* 5,000. *Estimated Time per Respondent:* 15 minutes. *Estimated Total Annual Burden Hours:* 1,250. *Request for Comments:* Comments submitted in response to this notice will be summarized and/or included in the request for OMB approval. All comments will become a matter of public record. Comments are invited on:
(a)Whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility;
(b)the accuracy of the agency's estimate of the burden of the collection of information;
(c)ways to enhance quality, utility, and clarity of the information to be collected;
(d)ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and
(e)estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information. Dated: January 3, 2008. Brian Lallemont, Records Management Program Manager. [FR Doc. E8-244 Filed 1-8-08; 8:45 am] BILLING CODE 4810-39-P DEPARTMENT OF VETERANS AFFAIRS [OMB Control No. 2900-New (VSO Access)] Agency Information Collection: Emergency Submission for OMB Review; Comment Request AGENCY: Veterans Health Administration, Department of Veterans Affairs. ACTION: Notice. SUMMARY: In compliance with the Paperwork Reduction Act
(PRA)of 1995 (44 U.S.C. 3501-3521), this notice announces that the United States Department of Veterans Affairs
(VA)will submit to the Office of Management and Budget
(OMB)the following emergency proposal for the collection of information under the provisions of the Paperwork Reduction Act (44 U.S.C. 3507(j)(1)). An emergency clearance is being requested to establish computer accounts for Veteran Service Officers to access VA's Veterans Health Information Systems Technology Architecture (VistA). DATES: Comments must be submitted on or before January 23, 2008. ADDRESSES: Submit written comments on the collection of information through *http://www.Regulations.gov* ; or to VA's OMB Desk Officer, OMB Human Resources and Housing Branch, New Executive Office Building, Room 10235, Washington, DC 20503,
(202)395-7316. Please refer to “OMB Control No. 2900-New (VSO Access)” in any correspondence. FOR FURTHER INFORMATION CONTACT: Denise McLamb, Records Management Service (005R1B), Department of Veterans Affairs, 810 Vermont Avenue, NW., Washington, DC 20420,
(202)461-7485, fax
(202)273-0443 or e-mail *denise.mclamb@mail.va.gov* . Please refer to “OMB Control No. 2900-New (VSO Access).” SUPPLEMENTARY INFORMATION: *Title:* VSO Access to VHA Electronic Health Records, VA Form 10-0400. *OMB Control Number:* 2900-New (VSO Access). *Type of Review:* New collection. *Abstract:* VSO's complete VA Form 10-0400 to request authorization to access VA VistA database. VA will use the data collected to provide VSO's who were granted power of attorney by veterans with medical information recorded in VHA electronic health records system, authorization to access medical information needed to process a veteran's compensation and pension claim. *Affected Public:* Individuals or households. *Estimated Total Annual Burden:* 3 hours. *Estimated Average Burden per Respondent:* 2 minutes. *Frequency of Response:* One time. *Estimated Number of Respondents:* 80. Dated: January 3, 2008. By direction of the Secretary. Denise McLamb, Program Analyst, Records Management Service. [FR Doc. E8-122 Filed 1-8-08; 8:45 am] BILLING CODE 8320-01-P 73 6 Wednesday, January 9, 2008 Proposed Rules Part II Federal Reserve System 12 CFR Part 226 Truth in Lending; Proposed Rule FEDERAL RESERVE SYSTEM 12 CFR Part 226 [Regulation Z; Docket No. R-1305] Truth in Lending AGENCY: Board of Governors of the Federal Reserve System. ACTION: Proposed rule; request for public comment. SUMMARY: The Board proposes to amend Regulation Z, which implements the Truth in Lending Act and Home Ownership and Equity Protection Act. The goals of the amendments are to protect consumers in the mortgage market from unfair, abusive, or deceptive lending and servicing practices while preserving responsible lending and sustainable homeownership; ensure that advertisements for mortgage loans provide accurate and balanced information and do not contain misleading or deceptive representations; and provide consumers transaction-specific disclosures early enough to use while shopping for a mortgage. The proposed revisions would apply four protections to a newly-defined category of higher-priced mortgage loans secured by a consumer's principal dwelling, including a prohibition on a pattern or practice of lending based on the collateral without regard to consumers' ability to repay their obligations from income, or from other sources besides the collateral. The proposed revisions would apply three new protections to mortgage loans secured by a consumer's principal dwelling regardless of loan price, including a prohibition on a creditor paying a mortgage broker more than the consumer had agreed the broker would receive. The Board also proposes to require that advertisements provide accurate and balanced information, in a clear and conspicuous manner, about rates, monthly payments, and other loan features; and to ban several deceptive or misleading advertising practices, including representations that a rate or payment is “fixed” when it can change. Finally, the proposal would require creditors to provide consumers with transaction-specific mortgage loan disclosures before they pay any fee except a reasonable fee for reviewing credit history. DATES: Comments must be received on or before April 8, 2008. ADDRESSES: You may submit comments, identified by Docket No. R-1305, by any of the following methods: • *Agency Web site: http://www.federalreserve.gov.* Follow the instructions for submitting comments at *http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.* • *Federal eRulemaking Portal: http://www.regulations.gov.* Follow the instructions for submitting comments. • *E-mail: regs.comments@federalreserve.gov.* Include the docket number in the subject line of the message. • *Fax:*
(202)452-3819 or
(202)452-3102. • *Mail:* Address to Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551. All public comments will be made available on the Board's Web site at *http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm* as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP-500 of the Board's Martin Building (20th and C Streets, NW.) between 9 a.m. and 5 p.m. on weekdays. FOR FURTHER INFORMATION CONTACT: Kathleen C. Ryan, Dan S. Sokolov, or David Stein, Counsels; Jamie Z. Goodson, Brent Lattin, Jelena McWilliams, or Paul Mondor, Attorneys; Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, Washington, DC 20551, at
(202)452-2412 or
(202)452-3667. For users of Telecommunications Device for the Deaf
(TDD)only, contact
(202)263-4869. SUPPLEMENTARY INFORMATION: I. Summary of Proposal A. Proposals To Prevent Unfairness, Deception, and Abuse B. Proposals To Improve Mortgage Advertising C. Proposals To Give Consumers Disclosures Early II. Consumer Protection Concerns in the Subprime Market A. Recent Problems in the Mortgage Market B. The Loosening of Underwriting Standards C. Market Imperfections That Can Facilitate Abusive and Unaffordable Loans III. The Board's Hoepa Hearings A. Home Ownership and Equity Protection Act (HOEPA) B. Summary of 2006 Hearings C. Summary of June 2007 Hearing D. Congressional Hearings IV. Inter-Agency Supervisory Guidance V. Legal Authority A. The Board's Authority Under TILA Section 129(l)(2) B. The Board's Authority Under TILA Section 105(a) VI. Proposed Definition of “Higher-Priced Mortgage Loan” A. Overview B. Public Comment on the Scope of New HOEPA Rules C. General Principles Governing the Board's Determination of Coverage D. Types of Loans Proposed To Be Covered Under § 226.35 E. Proposed APR Trigger for § 226.35 F. Mechanics of the Proposed APR Trigger VII. Proposed Rules for Higher-Priced Mortgage Loans—§ 226.35 A. Overview B. Disregard of Consumers' Ability To Repay—§§ 226.34(a)(4) and 226.35(b)(1) C. Verification of Income and Assets Relied On—§ 226.35(b)(2) D. Prepayment Penalties—§ 226.32(d)(6) and (7); § 226.35(b)(3) E. Requirement to Escrow—§ 226.35(b)(4) F. Evasion Through Spurious Open-end Credit—§ 226.35(b)(5) VIII. Proposed Rules for Mortgage Loans—§ 226.36 A. Creditor Payments to Mortgage Brokers—§ 226.36(a) B. Coercion of Appraisers—§ 226.36(b) C. Servicing Abuses—§ 226.36(c) D. Coverage—§ 226.36(d) IX. Other Potential Concerns A. Other HOEPA Prohibitions B. Steering X. Advertising A. Advertising Rules for Open-end Home-equity Plans—§ 226.16 B. Advertising Rules for Closed-end Credit—§ 226.24 XI. Mortgage Loan Disclosures A. Early Mortgage Loan Disclosures—§ 226.19 B. Future Plans To Improve Disclosure XII. Civil Liability and Remedies; Administrative Enforcement XIII. Effective Date XIV. Paperwork Reduction Act XV. Initial Regulatory Flexibility Analysis I. Summary of Proposal The Board is proposing to establish new regulatory protections for consumers in the residential mortgage market through amendments to Regulation Z, which implements the Truth in Lending Act
(TILA)and the Home Ownership and Equity Protection Act (HOEPA). The goals of the amendments are to protect consumers in the mortgage market from unfair, abusive, or deceptive lending and servicing practices while preserving responsible lending and sustainable homeownership; ensure that advertisements for mortgage loans provide accurate and balanced information and do not contain misleading or deceptive representations; and provide consumers transaction-specific disclosures early enough to use while shopping. A. Proposals To Prevent Unfairness, Deception, and Abuse The Board is proposing seven new restrictions or requirements for mortgage lending and servicing intended to protect consumers against unfairness, deception, and abuse while preserving responsible lending and sustainable homeownership. The restrictions would be adopted under TILA Section 129(l)(2), which authorizes the Board to prohibit unfair or deceptive practices in connection with mortgage loans, as well as to prohibit abusive practices or practices not in the interest of the borrower in connection with refinancings. 15 U.S.C. 1639(l)(2). Some of the restrictions would apply only to higher-priced mortgage loans, while others would apply to all mortgage loans secured by a consumer's principal dwelling. Protections Covering Higher-Priced Mortgage Loans The Board is proposing four protections for consumers receiving higher-priced mortgage loans. These loans would be defined as consumer-purpose, closed-end loans secured by a consumer's principal dwelling and having an annual percentage rate
(APR)that exceeds the comparable Treasury security by three or more percentage points for first-lien loans, or five or more percentage points for subordinate-lien loans. For higher-priced mortgage loans, the Board proposes to: ○ Prohibit creditors from engaging in a pattern or practice of extending credit without regard to borrowers' ability to repay from sources other than the collateral itself; ○ Require creditors to verify income and assets they rely upon in making loans; ○ Prohibit prepayment penalties unless certain conditions are met; and ○ Require creditors to establish escrow accounts for taxes and insurance, but permit creditors to allow borrowers to opt out of escrows 12 months after loan consummation. In addition, the proposal would prohibit creditors from structuring closed-end mortgage loans as open-end lines of credit for the purpose of evading these rules, which do not apply to lines of credit. Protections Covering Closed-End Loans Secured by Consumer's Principal Dwelling In addition, in connection with all consumer-purpose, closed-end loans secured by a consumer's principal dwelling, the Board is proposing to: ○ Prohibit creditors from paying a mortgage broker more than the consumer had agreed in advance that the broker would receive; ○ Prohibit any creditor or mortgage broker from coercing, influencing, or otherwise encouraging an appraiser to provide a misstated appraisal in connection with a mortgage loan; and ○ Prohibit mortgage servicers from “pyramiding” late fees, failing to credit payments as of the date of receipt, failing to provide loan payoff statements upon request within a reasonable time, or failing to deliver a fee schedule to a consumer upon request. B. Proposals To Improve Mortgage Advertising Another goal of this proposal is to ensure that mortgage loan advertisements provide accurate and balanced information and do not contain misleading or deceptive representations. Thus the Board is proposing to require that advertisements for both open-end and closed-end mortgage loans provide accurate and balanced information, in a clear and conspicuous manner, about rates, monthly payments, and other loan features. This proposal is made under the Board's general authority to adopt regulations to ensure consumers are informed about and can shop for credit. TILA Section 105(a), 15 U.S.C. 1604(a). The Board is also proposing, under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), to prohibit the following seven deceptive or misleading practices in advertisements for closed-end mortgage loans: ○ Advertising “fixed” rates or payments for loans whose rates or payments can vary without adequately disclosing that the interest rate or payment amounts are “fixed” only for a limited period of time, rather than for the full term of the loan; ○ Comparing an actual or hypothetical consumer's current rate or payment obligations and the rates or payments that would apply if the consumer obtains the advertised product unless the advertisement states the rates or payments that will apply over the full term of the loan; ○ Advertisements that characterize the products offered as “government loan programs,” “government-supported loans,” or otherwise endorsed or sponsored by a federal or state government entity even though the advertised products are not government-supported or -sponsored loans; ○ Advertisements, such as solicitation letters, that display the name of the consumer's current mortgage lender, unless the advertisement also prominently discloses that the advertisement is from a mortgage lender not affiliated with the consumer's current lender; ○ Advertising claims of debt elimination if the product advertised would merely replace one debt obligation with another; ○ Advertisements that create a false impression that the mortgage broker or lender has a fiduciary relationship with the consumer; and ○ Foreign-language advertisements in which certain information, such as a low introductory “teaser” rate, is provided in a foreign language, while required disclosures are provided only in English. C. Proposal To Give Consumers Disclosures Early A third goal of this proposal is to provide consumers transaction-specific disclosures early enough to use while shopping for a mortgage loan. The Board proposes to require creditors to provide transaction-specific mortgage loan disclosures such as the APR and payment schedule for all home-secured, closed-end loans no later than three days after application, and before the consumer pays any fee except a reasonable fee for the originator's review of the consumer's credit history. The Board recognizes that these disclosures need to be updated to reflect the increased complexity of mortgage products. In early 2008, the Board will begin testing current TILA mortgage disclosures and potential revisions to these disclosures through one-on-one interviews with consumers. The Board expects that this testing will identify potential improvements for the Board to propose for public comment in a separate rulemaking. II. Consumer Protection Concerns in the Subprime Market A. Recent Problems in the Mortgage Market Subprime mortgage loans are made to borrowers who are perceived to have high credit risk. These loans' share of total consumer originations, according to one estimate, reached about nine percent in 2001 and doubled to 20 percent by 2005, where it stayed in 2006. 1 The resulting increase in the supply of mortgage credit likely contributed to the rise in the homeownership rate from 64 percent in 1994 to a high of 69 percent in 2006—though about 68 percent now—and expanded consumers' access to the equity in their homes. Recently, however, some of this benefit has eroded. In the last two years, delinquencies and foreclosure starts among subprime mortgages have increased dramatically and reached exceptionally high levels as house price growth has slowed or prices have declined in some areas. The proportion of all subprime mortgages past-due ninety days or more (“serious delinquency”) was about 13 percent in October 2007, more than double the mid-2005 level. 2 Adjustable-rate subprime mortgages have performed the worst, reaching a serious delinquency rate of nearly 19 percent in October 2007, triple the mid-2005 level. These mortgages have seen unusually high levels of early payment default, or default after only one or two payments or even no payment at all. 1 Inside Mortgage Finance Publications, Inc., *The 2007 Mortgage Market Statistical Annual* vol. I ( *IMF 2007 Mortgage Market* ), at 4. 2 Delinquency rates calculated from data from First American LoanPerformance on mortgages in subprime securitized pools. Figures include loans on non-owner-occupied properties. The serious delinquency rate has also risen for loans in alt-A (near prime) securitized pools. According to one source, originations of these loans were 13 percent of consumer mortgage originations in 2006. 3 Alt-A loans are made to borrowers who typically have higher credit scores than subprime borrowers, but the loans pose more risk than prime loans because they involve small down payments or reduced income documentation, or the terms of the loan are nontraditional and may increase risk. The rate of serious delinquency for these loans has risen to over 3 percent (as of September 2007) from 1 percent only a year ago. In contrast, 1 percent of loans in the prime-mortgage sector were seriously delinquent as of October. 3 *IMF 2007 Mortgage Market,* at 4. The consequences of default are severe for homeowners, who face the possibility of foreclosure, the loss of accumulated home equity, higher rates for other credit transactions, and reduced access to credit. When foreclosures are clustered, they can injure entire communities by reducing property values in surrounding areas. Higher delinquencies are in fact showing through to foreclosures. Lenders initiated 430,000 foreclosures in the third quarter of 2007, about half of them on subrpime mortgages. This was significantly higher than the quarterly average of 325,000 in the first half of the year, and nearly twice the quarterly average of 225,000 for the past six years. 4 4 Estimates are based on data from Mortgage Bankers' Association's *National Delinquency Survey* (2007). B. The Loosening of Underwriting Standards Rising delinquencies have been caused largely by a combination of a decline in house price appreciation—and in some areas slower economic growth—and a loosening of underwriting standards. Underwriting standards loosened in large parts of the mortgage market in recent years as lenders—particularly nondepository institutions, many of which have since ceased to exist—competed more aggressively for market share. This loosening was particularly pronounced in the subprime sector, where the frequent combination of several riskier loan attributes—high loan-to-value ratio, payment shock on adjustable-rate mortgages, no verification of borrower income, and no escrow for taxes and insurance—increased the risk of serious delinquency and foreclosure for subprime loans originated in 2005 through early 2007. Payment shock from rate adjustments within two or three years of origination could make these loans unaffordable to many of the consumers who hold them. Approximately three-fourths of originations in securitized subprime “pools” from 2004 to 2006 were adjustable-rate mortgages
(ARMs)with two-or three-year “teaser” rates followed by substantial increases in the rate and payment (so-called “2-28” and “3-27” mortgages). 5 The burden of these payment increases on the borrower would likely be heavier than expected if the borrower's stated income was inflated, as appears to have happened in some cases, and the inflated figure was used to determine repayment ability. In addition, affordability problems with subprime loans can be compounded by unexpected property tax and homeowners insurance obligations. In the prime market, lenders typically establish escrows for these obligations, but in the subprime market escrows have been the exception rather than the rule. 5 Figure calculated from First American Loan Performance data. Delinquencies and foreclosure initiations in subprime ARMs are expected to rise further as more of these mortgages see their rates and payments reset at significantly higher levels. On average in 2008, 374,000 subprime mortgages per quarter are scheduled to undergo their first interest rate and payment reset. Relative to past years, avoiding the payment shock of an interest rate reset by refinancing the mortgage will be much more difficult. Not only have home prices flattened out or declined, thereby reducing homeowners' equity, but borrowers often had little equity to start with because of very high initial cumulative loan-to-value ratios. Moreover, prepayment penalty clauses, which are found in a substantial majority of subprime loans, place an added demand on the limited equity or other resources available to many borrowers and make it harder still for them to refinance. Borrowers who cannot refinance will have to make sacrifices to stay in their homes or could lose their homes altogether. 6 6 These effects may be mitigated for some borrowers by a recently-announced agreement among major loan servicers and investors to “freeze” many subprime ARMs at their initial interest rates for five years. Relaxed underwriting was not limited to the subprime market. According to one estimate, interest-only mortgages (most of them with adjustable rates) and “option ARMs”—which permit borrowers to defer both principal and interest for a time in exchange for higher payments later—rose from 7 percent of total consumer mortgage originations in 2004 to 26 percent in 2006. 7 By one estimate these mortgages reached 78 percent of alt-A originations in 2006. 8 These types of mortgages hold the potential for payment shock and increasingly contained additional layers of risk such as loan amounts near the full appraised value of the home, and partial or no documentation of income. For example, the share of interest-only mortgages with low or no documentation in alt-A securitized pools increased from around 60 percent in 2003 to nearly 80 percent in 2006. 9 Most of these mortgages have not yet reset so their full implications are not yet apparent. The risks to consumers and to creditors were serious enough, however, to cause the federal banking agencies to issue supervisory guidance, which many state agencies later adopted. 10 7 *IMF 2007 Mortgage Market,* at 6. 8 David Liu & Shumin Li, *Alt-A Credit—The Other Shoe Drops?,* The MarketPulse (First American LoanPerformance, Inc., San Francisco, Cal.), Dec. 2006. 9 Figures calculated from First American LoanPerformance data. 10 Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609, Oct. 4, 2006. A decline in underwriting standards does not just increase the risk that consumers will be provided loans they cannot repay. It also increases the risk that originators will engage in an abusive strategy of “flipping” borrowers in a succession of refinancings, ostensibly to lower borrowers' burdensome payments, that strip borrowers' equity and provide them no benefit. Moreover, an atmosphere of relaxed standards may increase the incidence of abusive lending practices by attracting less scrupulous originators into the market, while at the same time bringing more vulnerable borrowers into the market. These abuses can lead consumers to pay more for their loans than their risk profiles warrant. The market has responded to the current problems with increasing attention to loan quality. Structural factors, or market imperfections, however, make it necessary to consider regulations to help prevent a recurrence of these problems. New regulation can also provide the market clear “rules of the road” at a time of uncertainty, so that responsible higher-priced lending, which serves a critical need, may continue. C. Market Imperfections That Can Facilitate Abusive and Unaffordable Loans The recent sharp increase in serious delinquencies has highlighted the roles that structural elements of the subprime mortgage market may play in increasing the likelihood of injury to consumers who find themselves in that market. Limitations on price and product transparency in the subprime market—often compounded by misleading or inaccurate advertising—may make it harder for consumers to protect themselves from abusive or unaffordable loans, even with the best disclosures. The injuries consumers in the subprime market may suffer as a result are magnified when originators' incentives to carefully assess consumers' repayment ability grow weaker, as can happen when originators sell off their loans to be securitized. The fragmentation of the originator market can further exacerbate the problem by making it more difficult for investors to monitor originators and for lenders to monitor brokers. The multiplicity of originators and their regulators can also inhibit the ability of regulators to protect consumers from abusive and unaffordable loans. Limited Transparency and Limits of Disclosure Limited transparency in the subprime market increases the risk that borrowers in that market will receive unaffordable or abusive loans. The transparency of the subprime market to consumers is limited in several respects. First, price information for the subprime market is not widely and readily available to consumers. A consumer searching in the prime market can buy a newspaper or access the Internet and easily find current interest rates from a wide variety of lenders without paying a fee. In contrast, subprime rates, which can vary significantly based on the individual borrower's risk profile, are not broadly advertised. Advertising in the subprime market focuses on easy approval and low payments. Moreover, a borrower shopping in the subprime market generally cannot obtain a useful rate quote from a particular lender without submitting an application and paying a fee. The quote may not even be reliable, as loan originators sometimes use “bait and switch” strategies. Second, products in the subprime market tend to be complex, both relative to the prime market and in absolute terms, as well as less standardized than in the prime market. 11 As discussed earlier, subprime originations have much more often had adjustable rates than more easily understood fixed rates. Adjustable-rate mortgages require consumers to make judgments about the future direction of interest rates and translate expected rate changes into changes in their payment amounts. Subprime loans are also far more likely to have prepayment penalties. The price of the penalty is not reflected in the annual percentage rate (APR); to calculate that price, the consumer must both calculate the size of the penalty according to a formula such as six months of interest, and assess the likelihood the consumer will move or refinance during the penalty period. In these and other ways subprime products tend to be complex for consumers. 11 U.S. Dep't of Hous. & Urban Dev. & U.S. Dep't of Treasury, *Recommendations to Curb Predatory Home Mortgage Lending* 17
(2000)(“While predatory lending can occur in the prime market, such practices are for the most part effectively deterred by competition among lenders, greater homogeneity in loan terms and the prime borrowers' greater familiarity with complex financial transactions.”); Howard Lax, Michael Manti, Paul Raca & Peter Zorn, *Subprime Lending: An Investigation of Economic Efficiency (Subprime Lending Investigation),* 15 Housing Policy Debate 3, 570
(2004)(stating that the subprime market lacks the “overall standardization of products, underwriting, and delivery systems” that is found in the prime market). Third, the roles and incentives of originators are not transparent. One source estimates that 60 percent or more of mortgages originated in the last several years were originated through a mortgage broker, often an independent entity, who takes loan applications from consumers and shops them to depository institutions or other lenders. 12 Anecdotal evidence indicates that consumers in both the prime and subprime markets often believe, in error, that a mortgage broker is obligated to find the consumer the best and most suitable loan terms available. For example, in a 2003 survey of older borrowers who had obtained prime or subprime refinancings, seventy percent of respondents with broker-originated refinance loans reported that they had relied “a lot” on their brokers to find the best mortgage for them. 13 Consumers who rely on brokers often are unaware, however, that a broker's interests may diverge from, and conflict with, their own interests. In particular, consumers are often unaware that a creditor pays a broker more to originate a loan with a rate higher than the rate the consumer qualifies for based on the creditor's underwriting criteria. 12 Data reported by Wholesale Access Mortgage Research and Consulting, Inc., available at *http://www.wholesaleaccess.com/8-17-07-prs.shtml; http://www.wholesaleaccess.com/7_28_mbkr.shtml* . 13 Kellie K. Kim-Sung & Sharon Hermanson, *Experiences of Older Refinance Mortgage Loan Borrowers: Broker- and Lender-Originated Loans,* Data Digest No. 83 (AARP Public Policy Inst., Washington, DC), Jan. 2003, at 3, available at *http://www.aarp.org/research/credit-debt/mortgages/experiences_of_older_refinance_mortgage_loan_borro.html* . *Limited shopping* . In this environment of limited transparency, consumers—particularly those in the subprime market—who have been told by an originator that they will receive a loan from that originator may reasonably decide not to shop further among originators or among loan options. The costs of further shopping may be significant, including completing another application form and paying yet another application fee. Delaying receipt of funds is another cost of continuing to shop, a potentially significant one for the many borrowers in the subprime market who are seeking to refinance their obligations to lower their debt payments at least temporarily, to extract equity in the form of cash, or both. 14 Nearly 90 percent of subprime ARMs used for refinancing in recent years were “cash out.” 15 14 *See* Anthony Pennington-Cross & Souphala Chomsisengphet, *Subprime Refinancing: Equity Extraction and Mortgage Termination* , 35 Real Estate Economics 2, 233
(2007)(reporting that 49% of subprime refinance loans involve equity extraction, compared with 26% of prime refinance loans); Marsha J. Courchane, Brian J. Surette, and Peter M. Zorn, *Subprime Borrowers: Mortgage Transitions and Outcomes (Subprime Outcomes)* , 29 J. of Real Estate Economics 4, 368-371
(2004)(discussing survey evidence that borrowers with subprime loans are more likely to have experienced major adverse life events (marital disruption; major medical problem; major spell of unemployment; major decrease of income) and often use refinancing for debt consolidation or home equity extraction); *Subprime Lending Investigation* , at 551-552 (citing survey evidence that borrowers with subprime loans have increased incidence of major medical expenses, major unemployment spells, and major drops in income). 15 Figure calculated from First American LoanPerformance data. While the cost of continuing to shop is likely obvious, the benefit may not be clear or may appear quite small. Without easy access to subprime product prices, a consumer who has been offered a loan by one originator may have only a limited idea whether further shopping is likely to produce a better deal. Moreover, consumers in the subprime market have reported in studies that they were turned down by several lenders before being approved. 16 Once approved, these consumers may see little advantage to continuing to shop if they expect, based on their experience, that many of their applications to other originators would be turned down. Furthermore, if a consumer uses a broker and believes that the broker is shopping for the consumer, the consumer may believe the chance of finding a better deal than the broker is small. An unscrupulous originator may also seek to discourage a consumer from shopping by intentionally understating the cost of an offered loan. For all of these reasons, borrowers in the subprime market may not shop beyond the first approval and may be willing to accept unfavorable terms. 17 16 James M. Lacko & Janis K. Pappalardo, Fed. Trade Comm'n, *Improving Consumer Mortgage Disclosures: An Empirical Assessment of Current and Prototype Disclosure Forms (Improving Mortgage Disclosures)* , 24-26
(2007)(reporting evidence based on qualitative consumer interviews); Subprime Lending Investigation, at 550 (finding based on survey data that “[p]robably the most significant hurdle overcome by subprime borrowers * * * is just getting approved for a loan for the first time. This impact might well make subprime borrowers more willing to accept less favorable terms as they become uncertain about the possibility of qualifying for a loan at all.”). 17 *Subprime Outcomes* , at 371-372 (reporting survey evidence that relative to prime borrowers, subprime borrowers are less knowledgeable about the mortgage process, search less for the best rates, and feel they have less choice about mortgage terms and conditions); *Subprime Mortgage Investigation* , at 554 (“Our focus groups suggested that prime and subprime borrowers use quite different search criteria in looking for a loan. Subprime borrowers search primarily for loan approval and low monthly payments, while prime borrowers focus on getting the lowest available interest rate. These distinctions are quantitatively confirmed by our survey.”). *Limited focus* . Consumers considering obtaining a typically complex subprime mortgage loan may simplify their decision by focusing on a few attributes of the product or service that seem most important. 18 A consumer may focus on loan attributes that have the most obvious and immediate consequence such as loan amount, down payment, initial monthly payment, initial interest rate, and up-front fees (though up-front fees may be more obscure when added to the loan amount, and “discount points” in particular may be difficult for consumers to understand). These consumers, therefore, may not focus on terms that may seem less immediately important to them such as future increases in payment amounts or interest rates, prepayment penalties, and negative amortization. They are also not likely to focus on underwriting practices such as income verification, and on features such as escrows for future tax and insurance obligations. 19 Consumers who do not fully understand such terms and features, however, are less able to appreciate their risks, which can be significant. For example, the payment may increase sharply and a prepayment penalty may hinder the consumer from refinancing to avoid the payment increase. Thus, consumers may unwittingly accept loans that they will have difficulty repaying. 18 Jinkook Lee & Jeanne M. Hogarth, *Consumer Information Search for Home Mortgages: Who, What, How Much, and What Else? (Consumer Information Search)* , Financial Services Review 291
(2000)(“In all, there are dozens of features and costs disclosed per loan, far in excess of the combination of terms, lenders, and information sources consumers report using when shopping.”). 19 *Consumer Information Search* , at 285 (reporting survey evidence that most consumers compared interest rate or APR, loan type (fixed-rate or ARM), and mandatory up-front fees, but only a quarter considered the costs of optional products such as credit insurance and back-end costs such as late fees). There is evidence that borrowers are not aware of, or do not understand, terms of this nature even after they have obtained a loan. *See Improving Mortgage Disclosures* , at 27-30 (discussing anecdotal evidence based on consumer interviews that borrowers were not aware of, did not understand, or misunderstood an important cost or feature of their loans that had substantial impact on the overall cost, the future payments, or the ability to refinance with other lenders); Brian Bucks & Karen Pence, *Do Homeowners Know Their House Values and Mortgage Terms?* 18-22 (Fed. Reserve Bd. of Governors Fin. and Econ. Discussion Series Working Paper No. 2006-3, 2006) (discussing statistical evidence that borrowers with ARMs underestimate annual as well as life-time caps on the interest rate; the rate of underestimation increases for lower-income and less-educated borrowers), available at *http://www.federalreserve.gov/pubs/feds/2006/200603/200603pap.pdf* . *Limits of disclosure* . Disclosures describing the multiplicity of features of a complex loan could help some consumers in the subprime market, but disclosures may not be sufficient to protect them against unfair loan terms or lending practices. Obtaining widespread consumer understanding of the many potentially significant features of a typical subprime product is a major challenge. 20 Moreover, even if all of a loan's features are disclosed clearly to consumers, they may continue to focus on a few features that appear most significant. Alternatively, disclosing all features may “overload” consumers and make it more difficult for them to discern which features are most important. 20 *Improving Mortgage Disclosures* , at 74-76 (finding that borrowers in the subprime market may have more difficulty understanding their loan terms because their loans are more complex than loans in the prime market). Furthermore, a consumer cannot make effective use of disclosures without having a certain minimum level of understanding of the market and products. Disclosures themselves, likely cannot provide this minimum understanding for transactions that are complex and that consumers engage in infrequently. Moreover, consumers may rely more on their originators to explain the disclosures when the transaction is complex; some originators may have incentives to misrepresent the disclosures so as to obscure the transaction's risks to the consumer; and such misrepresentations may be particularly effective if the originator is face-to-face with the consumer. 21 Therefore, while the Board anticipates proposing changes to Regulation Z to improve mortgage loan disclosures, it appears unlikely that better disclosures, alone, will address adequately the risk of abusive or unaffordable loans in the subprime market. 21 U.S. Gen. Accounting Office, GAO 04-280, *Consumer Protection: Federal and State Agencies Face Challenges in Combating Predatory Lending* 97-98
(2004)(stating that the inherent complexity of mortgage loans, some borrowers' lack of financial sophistication, education, or infirmities, and misleading statements and actions by lenders and brokers limit the effectiveness of even clear and transparent disclosures). Misaligned Incentives and Obstacles to Monitoring Not only are consumers in the subprime market often unable to protect themselves from abusive or unaffordable loans, originators may at certain times be more likely to extend unaffordable loans. The recent sharp rise in serious delinquencies on subprime mortgages has made clear that originators may not give adequate attention to repayment ability if they sell the mortgages they originate and bear little loss if the mortgages default. The growth of the secondary market gave lenders—and, thus, mortgage borrowers—greater access to capital markets, lowered transaction costs, and allowed risk to be shared more widely. This “originate-to-distribute” model, however, may also tend to contribute to the loosening of underwriting standards, particularly during periods of rapid house price appreciation, which may mask problems by keeping default and delinquency rates low until price appreciation slows or reverses. This potential tendency has several related causes. First, when an originator sells a mortgage and its servicing rights, depending on the terms of the sale, most or all of the risks typically are passed on to the loan purchaser. Thus, originators who sell loans may have less of an incentive to undertake careful underwriting than if they kept the loans. Second, warranties by sellers to purchasers and other “repurchase” contractual provisions have little meaningful benefit if originators have limited assets. Third, fees for some loan originators have been tied to loan volume, making loan sales—sometimes accomplished through aggressive “push marketing”—a higher priority than loan quality for some originators. Fourth, investors may not exercise adequate due diligence on mortgages in the pools in which they are invested, and may instead rely heavily on credit-ratings firms to determine the quality of the investment. The fragmentation of the originator market can further exacerbate the problem. Data reported under HMDA show that independent mortgage companies—those not related to depository institutions or their subsidiaries or affiliates—made nearly one-half of higher-priced first-lien mortgages in 2005 and 2006 but only one-fourth of loans that were not higher-priced. Nor was lending by independent mortgage companies particularly concentrated: In each of 2005 and 2006 around 150 independent mortgage companies made 500 or more higher-priced first-lien mortgage loans on owner-occupied dwellings. In addition, one source suggests that 60 percent or more of mortgages originated in the last several years were originated through a mortgage broker. 22 This same source estimates the number of brokerage companies at over 50,000 in recent years. 22 Data reported by Wholesale Access Mortgage Research and Consulting, Inc. Available at *http://www.wholesaleaccess.com/8-17-07-prs.shtml; http://www.wholesaleaccess.com/7_28_mbkr.shtml* . Thus, a securitized pool of mortgages may have been sourced by tens of lenders and thousands of brokers. Investors have limited ability to directly monitor these originators' activities. Similarly, a lender may receive a handful of loans from each of hundreds or thousands of small brokers every year. A lender has limited ability or incentive to monitor every small brokerage's operations and performance. Government oversight of such a fragmented originator market faces significant challenges. The various lending institutions and brokers operate in fifty different states and the District of Columbia with different regulatory and supervisory regimes, varying resources for supervision and enforcement, and different practices in sharing information among regulators. State regulatory regimes come under particular pressure when a booming market brings new lenders and brokers into the marketplace more rapidly than regulators can increase their oversight resources. These circumstances may inhibit the ability of regulators to protect consumers from abusive and unaffordable loans. A Role for New HOEPA Rules As explained above, consumers in the subprime market face serious constraints on their ability to protect themselves from abusive or unaffordable loans, even with the best disclosures; originators themselves may at times lack sufficient market incentives to ensure loans they sell are affordable; and regulators face limits on their ability to oversee a fragmented subprime origination market. These circumstances appear to warrant imposing a new national legal standard on subprime lenders to help ensure that consumers receive mortgage loans they can afford to repay, and help prevent the equity-stripping abuses that unaffordable loans facilitate. Adopting this standard under authority of HOEPA would ensure that it applied uniformly to all originators and provide consumers an opportunity to redress wrongs through civil actions to the extent authorized by TILA. As explained in the next part, substantial information supplied to the Board through several public hearings confirms the need for new HOEPA rules. III. The Board's HOEPA Hearings A. Home Ownership and Equity Protection Act (HOEPA) The Board has recently held extensive public hearings on consumer protection issues in the mortgage market, including the subprime sector. These hearings were held pursuant to the Home Ownership and Equity Protection Act (HOEPA), which directs the Board to hold public hearings periodically on the home equity lending market and the adequacy of existing law for protecting the interests of consumers, particularly low income consumers. HOEPA imposes substantive restrictions, and special pre-closing disclosures, on particularly high-cost refinancings and home equity loans (“HOEPA loans”). 23 These restrictions include limitations on prepayment penalties and “balloon payment” loans, and prohibitions of negative amortization and of engaging in a pattern or practice of lending based on the collateral without regard to repayment ability. 23 HOEPA loans are closed-end, non-purchase money mortgages secured by a consumer's principal dwelling (other than a reverse mortgage) where either:
(a)*The* APR at consummation will exceed the yield on Treasury securities of comparable maturity by more than 8 percentage points for first-lien loans, or 10 percentage points for subordinate-lien loans; or
(b)the total points and fees payable by the consumer at or before closing exceed the greater of 8 percent of the total loan amount, or $547 for 2007 (adjusted annually). When it enacted HOEPA, Congress granted the Board authority, codified in TILA Section 129(l), to create exemptions to HOEPA's restrictions and to expand its protections. 15 U.S.C. 1639(l). Under TILA Section 129(l)(1), the Board may create exemptions to HOEPA's restrictions as needed to keep responsible credit available; and under TILA Section 129(l)(2), the Board may adopt new or expanded restrictions as needed to protect consumers from unfairness, deception, or evasion of HOEPA. In HOEPA Section 158, Congress directed the Board to monitor changes in the home equity market through regular public hearings. Hearings the Board held in 2000 led the Board to expand HOEPA's protections in December 2001. 24 Those rules, which took effect in 2002, lowered HOEPA's rate trigger, expanded its fee trigger to include single-premium credit insurance, added an anti-“flipping” restriction, and improved the special pre-closing disclosure. 24 Truth in Lending, 66 FR 65604, 65608, Dec. 20, 2001. B. Summary of 2006 Hearings In the summer of 2006, the Board held four hearings in four cities on three broad topics:
(1)The impact of the 2002 HOEPA rule changes on predatory lending practices, as well as the effects on consumers of state and local predatory lending laws;
(2)nontraditional mortgage products and reverse mortgages; and
(3)informed consumer choice in the subprime market. Hearing panelists included mortgage lenders and brokers, credit ratings agencies, real estate agents, consumer advocates, community development groups, housing counselors, academicians, researchers, and state and federal government officials. In addition, consumers, housing counselors, brokers, and other individuals made brief statements at the hearings during an “open mike” period. In all, 67 individuals testified on panels and 54 comment letters were submitted to the Board. Consumer advocates and some state officials stated that HOEPA is generally effective in preventing abusive terms in loans subject to the HOEPA price triggers. They noted, however, that very few loans are made with rates or fees at or above the HOEPA triggers, and some advocated that Congress lower them. Consumer advocates and state officials also urged regulators and Congress to curb abusive practices in the origination of loans that do not meet HOEPA's price triggers. Consumer advocates identified several particular areas of concern. They urged the Board to prohibit or restrict certain loan features or terms, such as prepayment penalties, and underwriting practices such as “stated income” or “low documentation” (“low doc”) loans for which the borrower's income is not documented or verified. They also expressed concern about aggressive marketing practices such as steering borrowers to higher-cost loans by emphasizing initial low monthly payments based on an introductory rate without adequately explaining that the consumer will owe considerably higher monthly payments after the introductory rate expires. Some consumer advocates stated that brokers and lenders should be held to a higher duty such as a duty of good faith and fair dealing or a duty to make only loans suitable for the borrower. These advocates also urged the Board to ban “yield spread premiums,” payments that brokers receive from the lender at closing for delivering a loan with an interest rate that is higher than the lender's “buy rate,” because they provide brokers an incentive to increase consumers' interest rates. They argued that such steps would align reality with consumers' perceptions that brokers serve their best interests. Consumer advocates also expressed concerns that brokers, lenders, and others may coerce appraisers to misrepresent the value of a dwelling; and that servicers may charge consumers unwarranted fees and in some cases make it difficult for consumers who are in default to avoid foreclosure. Industry panelists and commenters, on the other hand, expressed concern that state predatory lending laws may reduce the availability of credit for some subprime borrowers. Most industry commenters opposed prohibiting stated income loans, prepayment penalties, or other loan terms, asserting that this approach would harm borrowers more than help them. They urged the Board and other regulators to focus instead on enforcing existing laws to remove “bad actors” from the market. Some lenders indicated, however, that restrictions on certain features or practices might be appropriate if the restrictions were clear and narrow. Industry commenters also stated that subjective suitability standards would create uncertainties for brokers and lenders and subject them to excessive litigation risk. C. Summary of June 2007 Hearing In light of the information received at the 2006 hearings and the rise in defaults that began soon after, the Board held an additional hearing in June 2007 to explore how it could use its authority under HOEPA to prevent abusive lending practices in the subprime market while still preserving responsible subprime lending. The Board focused the hearing on four specific areas: Lenders' determination of borrowers' repayment ability; “stated income” and “low doc” lending; the lack of escrows in the subprime market relative to the prime market; and the high frequency of prepayment penalties in the subprime market. At the hearing, the Board heard from 16 panelists representing consumers, mortgage lenders, mortgage brokers, and state government officials, as well as from academicians. The Board also received almost 100 written comments after the hearing from an equally diverse group. Industry representatives acknowledged concerns with recent lending practices but urged the Board to address most of these concerns through supervisory guidance rather than regulations under HOEPA. They maintained that supervisory guidance, unlike regulation, is flexible enough to preserve access to responsible credit. They also suggested that supervisory guidance issued recently regarding nontraditional mortgages and subprime lending, as well as market self-correction, have reduced the need for new regulations. Industry representatives support improving mortgage disclosures to help consumers avoid abusive loans. They urged that any substantive rules adopted by the Board be clearly drawn to limit uncertainty and narrowly drawn to avoid unduly restricting credit. In contrast, consumer advocates, state and local officials, and Members of Congress urged the Board to adopt regulations under HOEPA. They acknowledged a proper place for guidance but contended that recent problems indicate the need for requirements enforceable by borrowers through civil actions, which HOEPA enables and guidance does not. They also expressed concern that less responsible, less closely supervised lenders are not subject to the guidance and that there is limited enforcement of existing laws for these entities. Consumer advocates and others welcomed improved disclosures but insisted they would not prevent abusive lending. More detailed accounts of the testimony and letters are provided below in the context of specific issues the Board is proposing to address. D. Congressional Hearings Congress has also held a number of hearings in the past year about consumer protection concerns in the mortgage market. 25 In these hearings, Congress has heard testimony from individual consumers, representatives of consumer and community groups, representatives of financial and mortgage industry groups and federal and state officials. These hearings have focused on rising subprime foreclosure rates and the extent to which lending practices have contributed to them. 25 *E.g.* , *Progress in Administration and Other Efforts to Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing before the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Legislative Proposals on Reforming Mortgage Practices: Hearing before the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Legislative and Regulatory Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing before the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Ending Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S. Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on Banking, Hous., and Urban Affairs* , 110th Cong. (2007); *Improving Federal Consumer Protection in Financial Services: Hearing before the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *The Role of the Secondary Market in Subprime Mortgage Lending: Hearing before the Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Possible Responses to Rising Mortgage Foreclosures: Hearing before the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Subprime Mortgage Market Turmoil: Examining the Role of Securitization: Hearing before the Subcomm. on Secs., Ins., and Inv. of the S. Comm. on Banking, Hous., and Urban Affairs* , 110th Cong. (2007); *Subprime and Predatory Lending: New Regulatory Guidance, Current Market Conditions, and Effects on Regulated Financial Institutions: Hearing before the Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. Servs.* , 110th Cong. (2007); *Mortgage Market Turmoil: Causes and Consequences, Hearing before the S. Comm. on Banking, Hous., and Urban Affairs* , 110th Cong. (2007); *Preserving the American Dream: Predatory Lending Practices and Home Foreclosures, Hearing before the S. Comm. on Banking, Hous., and Urban Affairs* , 110th Cong. (2007). Consumer and community group representatives testified that certain lending terms or practices, such as hybrid adjustable-rate mortgages, prepayment penalties, low or no documentation loans, lack of escrows for taxes and insurance, and failure to consider the consumer's ability to repay have contributed to foreclosures. In addition, these witnesses testified that consumers often believe that mortgage brokers represent their interests and shop on their behalf for the best loan terms. As a result, they argue that consumers do not shop independently to ensure that they are getting the best terms for which they qualify. They also testified that, because originators sell most loans into the secondary market and do not share the risk of default, brokers and lenders have less incentive to ensure consumers can afford their loans. Financial services and mortgage industry representatives testified that consumers need better disclosures of their loan terms, but that substantive restrictions on subprime loan terms would risk reducing access to credit for some borrowers. In addition, these witnesses testified that applying a fiduciary duty to the subprime market, such as requiring that a loan be in the borrower's best interest, would introduce subjective standards that would significantly increase compliance and litigation risk. According to these witnesses, some lenders would be less willing to offer loans in the subprime market, making it harder for some consumers to get loans. IV. Inter-Agency Supervisory Guidance In December 2005, the Board and the other federal banking agencies responded to concerns about the rapid growth of nontraditional mortgages in the previous two years by proposing supervisory guidance. Nontraditional mortgages are mortgages that allow the borrower to defer repayment of principal and sometimes interest. The guidance advised institutions of the need to reduce “risk layering” practices with respect to these products, such as failing to document income or lending nearly the full appraised value of the home. The proposal, and the final guidance issued in September 2006, specifically advised lenders that layering risks in nontraditional mortgage loans to subprime borrowers may significantly increase risks to borrowers as well as institutions. 26 26 Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609, Oct. 4, 2006. The Board and the other federal banking agencies addressed concerns about the subprime market more broadly in March 2007 with a proposal addressing the heightened risks to consumers and institutions of ARMs with two or three-year “teaser” rates followed by substantial increases in the rate and payment. The guidance, finalized in June, sets out the standards institutions should follow to ensure borrowers in the subprime market obtain loans they can afford to repay. 27 Among other steps, the guidance advises lenders to
(1)use the fully-indexed rate and fully-amortizing payment when qualifying borrowers for loans with adjustable rates and potentially non-amortizing payments;
(2)limit stated income and reduced documentation loans to cases where mitigating factors clearly minimize the need for full documentation of income;
(3)provide that prepayment penalty clauses expire a reasonable period before reset, typically at least 60 days. 27 Statement on Subprime Mortgage Lending, 72 FR 37569, Jul. 10, 2007. The Conference of State Bank Supervisors
(CSBS)and American Association of Residential Mortgage Regulators (AARMR) issued parallel statements for state supervisors to use with state-supervised entities, and many states have adopted the statements. The guidance issued by the federal banking agencies has helped to promote safety and soundness and protect consumers in the subprime market. Guidance, however, is not necessarily implemented uniformly by all originators. Originators who are not subject to routine examination and supervision may not adhere to guidance as closely as originators who are. Guidance also does not provide individual consumers who have suffered harm because of abusive lending practices an opportunity for redress. The new and expanded consumer protections that the Board is proposing would apply uniformly to all creditors and be enforceable by federal and state supervisory and enforcement agencies and in many cases by borrowers. V. Legal Authority A. The Board's Authority Under TILA Section 129(l)(2) The substantive limitations in new proposed §§ 226.35 and 226.36 and corresponding revisions proposed for existing § 226.32, as well as proposed restrictions on misleading and deceptive advertisements, would be based on the Board's authority under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). That provision gives the Board authority to prohibit acts or practices in connection with: • Mortgage loans that the Board finds to be unfair, deceptive, or designed to evade the provisions of HOEPA; and • Refinancing of mortgage loans that the Board finds to be associated with abusive lending practices or that are otherwise not in the interest of the borrower. The authority granted to the Board under Section 129(l)(2), 15 U.S.C. 1639(l)(2), is broad both in absolute terms and relative to HOEPA's statutory prohibitions. For example, this authority reaches mortgage loans with rates and fees that do not meet HOEPA's rate or fee trigger in TILA Section 103(aa), 15 U.S.C. 1602(aa), as well as types of mortgage loans not covered under that section, such as home purchase loans. Nor is the Board's authority limited to regulating specific contractual terms of mortgage loan agreements; it extends to regulating loan-related practices generally, within the standards set forth in the statute. Moreover, while HOEPA's current restrictions apply only to creditors and only to loan terms or lending practices, TILA Section 129(l)(2) is not limited to creditors, nor is it limited to loan terms or lending practices. *See* 15 U.S.C. 1639(l)(2). It authorizes protections against unfair or deceptive practices when such practices are “in connection with mortgage loans,” and it authorizes protections against abusive practices “in connection with refinancing of mortgage loans.” HOEPA does not set forth a standard for what is unfair or deceptive, but the Conference Report for HOEPA indicates that, in determining whether a practice in connection with mortgage loans is unfair or deceptive, the Board should look to the standards employed for interpreting state unfair and deceptive trade practices acts and the Federal Trade Commission Act, Section 5(a), 15 U.S.C. 45(a). 28 28 H.R. Rep. 103-652, at 162
(1994)(Conf. Rep.). Congress has codified standards developed by the Federal Trade Commission for determining whether acts or practices are unfair under Section 5(a), 15 U.S.C. 45(a). 29 Under the Act, an act or practice is unfair when it causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In addition, in determining whether an act or practice is unfair, the FTC is permitted to consider established public policies, but public policy considerations may not serve as the primary basis for an unfairness determination. 30 29 *See* 15 U.S.C. 45(n); Letter from FTC to the Hon. Wendell H. Ford and the Hon. John C. Danforth (Dec. 17, 1980). 30 15 U.S.C. 45(n). The FTC has interpreted these standards to mean that consumer injury is the central focus of any inquiry regarding unfairness. 31 Consumer injury may be substantial if it imposes a small harm on a large number of consumers, or if it raises a significant risk of concrete harm. 32 The FTC looks to whether an act or practice is injurious in its net effects. 33 The agency has also observed that an unfair act or practice will almost always reflect a market failure or market imperfection that prevents the forces of supply and demand from maximizing benefits and minimizing costs. 34 In evaluating unfairness, the FTC looks to whether consumers' free market decisions are unjustifiably hindered. 35 31 Statement of Basis and Purpose and Regulatory Analysis, Credit Practices Rule (Credit Practices Rule), 42 FR 7740, 7743 March 1, 1984. 32 Letter from Commissioners of the FTC to the Hon. Wendell H. Ford, Chairman, and the Hon. John C. Danforth, Ranking Minority Member, Consumer Subcomm. of the H. Comm. on Commerce, Science, and Transp., n.12 (Dec. 17, 1980). 33 Credit Practices Rule, 42 FR at 7744. 34 *Credit Practices Rule at 7744.* 35 *Credit Practices Rule at 7744.* The FTC has also adopted standards for determining whether an act or practice is deceptive (though these standards, unlike unfairness standards, have not been incorporated into the FTC Act). 36 First, there must be a representation, omission or practice that is likely to mislead the consumer. Second, the act or practice is examined from the perspective of a consumer acting reasonably in the circumstances. Third, the representation, omission, or practice must be material. That is, it must be likely to affect the consumer's conduct or decision with regard to a product or service. 37 36 Letter from James C. Miller III, Chairman, FTC to the Hon. John D. Dingell, Chairman, H. Comm. on Energy and Commerce (Dingell Letter) (Oct. 14, 1983). 37 Dingell Letter at 1-2. Many states also have adopted statutes prohibiting unfair or deceptive acts or practices, and these statutes employ a variety of standards, many of them different from the standards currently applied to the FTC Act. A number of states follow an unfairness standard formerly used by the FTC. Under this standard, an act or practice is unfair where it offends public policy; or is immoral, unethical, oppressive, or unscrupulous; and causes substantial injury to consumers. 38 Some states require that a finding of deception be supported by a showing of intent to deceive, while other states only require showing that an act or practice is capable of being interpreted in a misleading way. 39 38 *See, e.g., Kenai Chrysler Ctr., Inc.* v. *Denison,* 167 P.3d 1240, 1255
(2007)(quoting *FTC* v. *Sperry & Hutchinson Co.,* 405 U.S. 233, 244-45 n.5 (1972)); *State* v. *Moran,* 151 N.H. 450, 452, 861 A.2d 763, 755-56
(2004)(concurrently applying the FTC's former test and a test under which an act or practice is unfair or deceptive if “the objectionable conduct * * * attain[s] a level of rascality that would raise an eyebrow of someone inured to the rough and tumble of the world of commerce.”) (citation omitted); *Robinson* v. *Toyota Motor Credit Corp.,* 201 Ill. 2d 403, 417-418, 775 N.E.2d 951, 961-62
(2002)(quoting 405 U.S. at 244-45 n.5). 39 *Compare Robinson,* 201 Ill. 2d at 417 (showing of intent to deceive required under Illinois Consumer Fraud Act) *with Kenai Chrysler Ctr.,* 167 P.3d at 1255 (no showing of intent to deceive required under Alaska Unfair Trade Practices Act). In proposing rules under TILA Section 129(l)(2)(A), 15 U.S.C. 1639(l)(2)(A), the Board has considered the standards currently applied to the FTC Act's prohibition against unfair or deceptive acts or practices, as well as the standards applied to similar state statutes. B. The Board's Authority Under TILA Section 105(a) Other aspects of this proposal are based on the Board's general authority under TILA Section 105(a) to prescribe regulations necessary or proper to carry out TILA's purposes. 15 U.S.C. 1604(a). This section is the basis for the proposal to require early disclosures for residential mortgage transactions as well as many of the proposals to improve advertising disclosures. These proposals are intended to carry out TILA's purposes of informing consumers about their credit terms and helping them shop for credit. See TILA Section 102, 15 U.S.C. 1603. VI. Proposed Definition of “Higher-Priced Mortgage Loan” A. Overview The Board proposes to extend certain consumer protections to a subset of consumer residential mortgage loans referred to as “higher-priced mortgage loans.” A creditor would be prohibited from engaging in a pattern or practice of making higher-priced mortgage loans based on the collateral without regard to repayment ability. A creditor would also be prohibited from making an individual higher-priced mortgage loan without: Verifying the consumer income and assets the creditor relied upon to make the loan; and establishing an escrow account for taxes and insurance. In addition, a higher-priced mortgage loan would not be permitted to have a prepayment penalty except under certain conditions. Finally, a creditor would be prohibited from structuring a closed-end mortgage loan as an open-end line of credit for the purpose of evading the restrictions on higher-priced mortgage loans, which would not apply to open-end lines of credit. This part VI discusses the proposed definition of a “higher priced mortgage loan” and a discussion of the specific protections that would apply to these loans follows in part VII. The Board is proposing to apply certain other restrictions to closed-end consumer mortgage loans secured by the consumer's principal dwelling without regard to loan price. These restrictions are discussed separately in part VIII. Higher-priced mortgage loans would be defined as consumer credit transactions secured by the consumer's principal dwelling for which the APR on the loan exceeds the yield on comparable Treasury securities by at least three percentage points for first-lien loans, or five percentage points for subordinate lien loans. The proposed definition would include home purchase loans, refinancings of loans, and home equity loans. The definition would exclude home equity lines of credit (“HELOCs”). In addition, there would be exclusions for reverse mortgages, construction-only loans, and bridge loans. The definition of “higher-priced mortgage loans” would appear in proposed § 226.35(a). Such loans would be subject to the restrictions and requirements in § 226.35(b) concerning repayment ability, income verification, prepayment penalties, escrows, and evasion, except that subordinate-lien higher-priced mortgage loans would not be subject to the escrow requirement. B. Public Comment on the Scope of New HOEPA Rules The June 14, 2007 hearing notice solicited comment on the following questions concerning coverage: • Whether terms or practices discussed in the hearing notice should be prohibited or restricted for all mortgage loans, or only for loans offered to subprime borrowers? • Whether terms or practices should be prohibited or restricted for loans to first-time homebuyers, home purchase loans, or refinancings and home equity loans? • Whether terms or practices should be prohibited or restricted only for certain products, such as adjustable-rate mortgages or nontraditional mortgages? Many commenters addressed the scope of any rules the Board might propose. Some consumer and community groups favored applying some or all prohibitions to the entire mortgage market, though other groups recommended that certain protections (e.g., for repayment ability) be applied to the entire market and others (e.g., for escrows) only to subprime and nontraditional loans. In general, financial institutions and financial services groups maintained that new rules should not be applied to the entire market. Most commenters suggested that, to the extent the Board targets subprime loans, it do so based on loan characteristics rather than borrower characteristics such as credit score. Some commenters proposed that coverage be determined by a loan's annual percentage rate
(APR)and suggested various approaches based on lender reporting of “higher-priced loans” under Regulation C, which implements the Home Mortgage Disclosure Act (HMDA). Several industry commenters, however, pointed out drawbacks of using an approach based on HMDA reporting and advocated instead that the Board cover only loans with “payment shock.” C. General Principles Governing the Board's Determination of Coverage Four main principles will guide the Board's determination of appropriate coverage. First, new regulations should be applied as broadly as needed to protect consumers from actual or potential injury, but not so broadly that the costs, including the always-present risk of unintended consequences, would clearly outweigh the benefits. Evidence that consumers have actually been injured by a particular practice in a particular market segment is important to determining proper coverage. Protection may also be needed in a particular segment, however, to prevent potential future injury in that segment or to limit adverse effects should lenders circumvent protections applied to another segment. Second, the most practical and effective way to protect borrowers is to apply protections based on loan characteristics, rather than borrower characteristics. Identifying a class of protected borrowers would present operational difficulties and other problems. For example, it is common to distinguish borrowers by credit score, with lower-scoring borrowers generally considered to be at higher risk of injury in the mortgage market. Defining the protected field as lower-scoring consumers would fail to protect higher-scoring consumers “steered” to loans meant for lower-scoring consumers. Moreover, the market uses different commercial scores, and choosing a particular score as the benchmark for a regulation could give unfair advantage to the company that provides that score. Third, the rule identifying higher-priced loans should be as simple as reasonably possible, consistent with protecting consumers and minimizing costs. For the sake of simplicity, the same coverage rule should apply to all new protections except where the benefit of tailoring coverage criteria to specific protections outweighs the increased complexity. Fourth, the rule should give lenders a reasonable degree of certainty during the application process regarding whether a transaction, when completed, will be covered by a particular protection. For some protections, reasonable certainty may be needed early in the application process; for other protections, it may not be needed until later. Reasonable certainty does not mean complete certainty. A rule that would provide lenders complete certainty about coverage early in the application process is likely not achievable. D. Types of Loans Proposed To Be Covered Under § 226.35 The Board's proposed definition of “higher-priced mortgage loan” has two main aspects. The first aspect is loan type—the definition includes certain types of loans (such as home purchase loans) and excludes others (such as HELOCs). The second aspect is loan price—the definition includes only loans with APRs exceeding specified thresholds. The first aspect of the definition, loan type, is discussed immediately below, and the second is discussed thereafter. The Board proposes to apply the protections of § 226.35 to first-lien, as well as subordinate-lien, closed-end mortgage loans secured by the consumer's principal dwelling, including home purchase loans, refinancings of loans, and home equity loans. The proposed definition would not cover loans that do not have primarily a consumer purpose, such as loans for real estate investment. The proposed definition also would not cover HELOCs, reverse mortgages, construction-only loans, or bridge loans. Coverage of Home Purchase Loans, Refinancings, and Home Equity Loans The statutory protections for HOEPA loans are generally limited to closed-end refinancings and home equity loans. *See* TILA Section 103(aa), 15 U.S.C. 1602(aa). The Board proposes to apply the protections of § 226.35 to loans of these types, which have historically presented the greatest risk to consumers. These loans are often made to consumers who have home equity and, therefore, have an existing asset at risk. These loans also can be marketed aggressively by originators to homeowners who may not benefit from them and who, if responding to the marketing and not shopping independently, may have limited information about their options. The Board proposes to use its authority under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), to cover home purchase loans as well. Covering only refinancings of home purchase loans would fail to protect consumers adequately. From 2003 to 2006, 44 percent of the higher-risk ARMs that came to dominate the subprime market in recent years were extended to consumers to purchase a home. 40 Delinquencies on subprime ARMs used for home purchase have risen sharply just as they have for refinancings. Moreover, comments and testimony at the Board's hearings indicate that the problems with abusive lending practices are not confined to refinancings and home equity loans. 40 Figure calculated from First American LoanPerformance data. Furthermore, consumers who are seeking home purchase loans can face unique constraints on their ability to make decisions. First-time homebuyers are likely unfamiliar with the mortgage market. Homebuyers generally are primarily focused on acquiring a new home, arranging to move into it, and making other life plans related to the move, such as placing their children in new schools. These matters can occupy much of the time and attention consumers might otherwise devote to shopping for a loan and deciding what loan to accept. Moreover, even if the consumer comes to understand later in the application process that an offered loan may not be appropriate, the consumer may not be able to reject the loan without risk of abrogating the sales agreement and losing a substantial deposit, as well as disrupting moving plans. Coverage of Subordinate-Lien Loans The Board is proposing to apply the proposed new protections—with the exception of the requirement to establish escrows—to subordinate-lien loans. (The reasons for this exception are discussed below under part VII.D.) The Board seeks comment on whether other exceptions would be appropriate. For example, should the Board limit coverage of all or some of the proposed restrictions to certain kinds of subordinate-lien loans such as “piggy backs” to first-lien loans, or subordinate-lien loans that are larger than the first-lien loan? Limitation to Loans Secured by Principal Dwelling; Exclusion of Loans for Investment The Board is proposing to limit the protections in proposed § 226.35 to loans secured by the consumer's principal dwelling. The Board's primary concern is to ensure that consumers not lose the homes they principally occupy because of unfair, abusive, or deceptive lending practices. The inevitable costs of new regulation, including potential unintended consequences, can most clearly be justified when people's principal homes are at stake. Limiting the proposed protections to loans secured by the principal dwelling would have the effect of excluding many, but not all, loans to purchase second homes. A loan to a consumer to purchase a second home, for example, would not be covered by these protections if the loan was secured only by the second home or by another dwelling (such as an investment property) other than the consumer's principal dwelling. Such a loan would, however, be covered if it was instead secured by the consumer's principal dwelling. Limiting the proposed protections to loans secured by the principal dwelling—and to loans having primarily a consumer purpose—would also have the effect of excluding loans primarily for a real estate investment purpose. This exclusion is consistent with TILA's focus on consumer concerns and its exclusion in Section 104 of credit primarily for business, commercial, or agricultural purposes. *See* 15 U.S.C. 1603(1). Real estate investors are expected to be more sophisticated than ordinary consumers about the real estate financing process and to have more experience with it, especially if they invest in several properties. Accordingly, the need to protect investors is not clear, and in any event is likely not sufficient to justify the potential unintended consequences of imposing restrictions, with civil liability if they are violated, on the financing of real estate investment transactions. The Board shares concerns that individuals who invest in residential real estate and do not pay their mortgage obligations put tenants at risk of eviction in the event of foreclosure. Regulating the rights of landlords and tenants, however, is traditionally a matter for state and local law. The Board believes that state and local law could better address this particular tenant protection concern than a Board regulation. Exclusion of HELOCs The Board proposes to exclude HELOCs from the proposed protections. These transactions do not appear to present as clear a need for new regulations as closed-end transactions. Most originators of HELOCs hold them in portfolio rather than sell them, which aligns these originators' interests in loan performance more closely with their borrowers' interests. In addition, TILA and Regulation Z provide borrowers special protections for HELOCs such as restrictions on changing plan terms. And, unlike originations of higher-priced closed-end mortgage loans, HELOC originations are concentrated in the banking and thrift industries, where the federal banking agencies can use supervisory authorities to protect borrowers. For example, when inadequate underwriting of HELOCs unduly increased risks to originators and consumers several years ago, the agencies responded with guidance. 41 For these reasons, the Board is not proposing to cover HELOCs. 41 Interagency Credit Risk Guidance for Home Equity Lending, May 16, 2005. Available at *http://www.federalreserve.gov/boarddocs/srletters/2005/sr0511a1.pdf.* Addendum to Credit Risk Guidance for Home Equity Lending, Sept. 29, 2006. Available at *http://www.federalreserve.gov/BoardDocs/SRLetters/2006/SR0615a3.pdf.* The Board recognizes, however, that HELOCs may represent a risk of circumvention. Creditors may seek to evade limitations on closed-end transactions by structuring such transactions as open-end transactions. In proposed § 226.35(b)(5), discussed below in part VII.F., the Board proposes to prohibit structuring a closed-end loan as an open-end transaction for the purpose of evading the new rules in § 226.35. To the extent it may instead be appropriate to apply those rules directly to HELOCs, the Board seeks comment on how an APR threshold for HELOCs could be set to achieve the objectives, discussed further in subpart E., of covering the subprime market and generally excluding the prime market. Exclusion of Reverse Mortgages and Construction-Only Loans The Board proposes to exclude reverse mortgages and construction-only loans from the new protections in § 226.35(b). A reverse mortgage is defined in current § 226.33(a), and the proposal would retain this definition. The Board heard from panelists about reverse mortgages at its 2006 HOEPA hearings and has not identified significant abuses in the reverse mortgage market. Moreover, reverse mortgages are unique transactions that present unique risks that are currently addressed by Regulation Z § 226.33. At an appropriate time, the Board will review § 226.33 and consider whether new or different protections are needed for reverse mortgages. The Board would also exclude from § 226.35's protections a construction-only loan, defined as a loan solely for the purpose of financing the initial construction of a dwelling, consistent with the definition of a “residential mortgage transaction” in § 226.2(a)(24). A construction-only loan would not include the permanent financing that replaces a construction loan. Construction-only loans do not appear to present the same risk of consumer abuse as other loans the proposal would cover. The permanent financing, or a new home-secured loan following construction, would be covered by proposed § 226.35. Applying § 226.35 to construction-only loans, which generally have higher interest rates than the permanent financing, could hinder some borrowers' access to construction financing without meaningfully enhancing consumer protection. Exclusion of Bridge Loans Proposed § 226.35(a)(5) would exempt from § 226.35 temporary or “bridge loans” with a term of no more than twelve months. The regulation would give as an example a loan that a consumer takes to “bridge” between the purchase of a new dwelling and the sale of the consumer's existing dwelling. HOEPA now covers certain bridge loans with rates or fees high enough to make them HOEPA loans. TILA Section 129(l)(1) provides the Board authority to exempt classes of mortgage transactions from HOEPA if the Board finds that the exemption is in the interest of the borrowing public and will apply only to products that maintain and strengthen homeownership and equity protection. 15 U.S.C. 1639(l)(2). The Board believes a narrow exemption from HOEPA for bridge loans would be in borrowers' interest and support homeownership. The Board seeks comment on the proposed exemption. E. Proposed APR Trigger for § 226.35 Overview The Board proposes to use an APR trigger to define the range of transactions that would be covered by the protections of proposed § 226.35. The Board seeks to set the trigger at a level that would capture the subprime market but generally exclude the prime market. There is, however, inherent uncertainty as to what level would achieve these objectives. The Board believes that it may be appropriate, in the face of this uncertainty, to err on the side of covering somewhat more than the subprime market. Based on this approach, the Board proposes a threshold of three percentage points above the comparable Treasury security for first-lien loans, or five percentage points for subordinate-lien loans. Based on available data, it appears that this threshold would capture at least the higher-priced end of the alt-A market. The Board seeks comment, and solicits data, on the extent to which the threshold would cover the alt-A market, and on the benefits and costs, including any potential unintended consequences for consumers, of applying any or all of the protections in § 226.35 to the alt-A market to the extent it would be covered. The Board also seeks comment on whether a different threshold, such as four percentage points for first-lien loans (and six percentage points for subordinate-lien loans), would better satisfy the objectives of covering the subprime market, excluding the prime market, and avoiding unintended consequences for consumers in the alt-A market. Reasons To Use APR The APR corresponds closely to credit risk, that is, the risk of default as well as the closely related risks of serious delinquency and foreclosure. Loans with higher APRs generally have higher credit risks, whatever the source of the risk might be—weaker borrower credit histories, higher borrower debt-to-income ratios, higher loan-to-value ratios, less complete income or asset documentation, less traditional loan terms or payment schedules, or combinations of these or other risk factors. Since disclosing an APR has long been required by TILA, the figure is also very familiar and readily available to creditors and consumers. Therefore, the Board believes it appropriate to use a loan's APR to identify loans having a high enough credit risk to warrant the protections of proposed § 226.35. The APR for two loans with identical risk characteristics can be different at different times solely because of market changes in mortgage rates. The Board proposes to control for such market changes by comparing a loan's APR to the yield on the comparable Treasury security. This would be similar, but not identical, to the approach HOEPA uses currently to identify HOEPA-covered loans, *see* TILA Section 103(aa), 15 U.S.C. 1602(aa), and § 226.32(a), and Regulation C uses to identify higher-priced loans reportable under HMDA, *see* 12 CFR 203.4(a)(12). The Board is aware of concerns that the method that these regulations use to match mortgage loans to Treasuries leads to some inaccuracy in coverage and makes coverage vary with changes in the yield curve (the relationship between short-term and long-term interest rates). As discussed in more detail below, the Board is proposing to address these concerns in the context of § 226.35. Coverage Objectives The Board set forth above a general principle that new regulations should be applied as broadly as needed to protect consumers from actual or potential injury, but not so broadly that the costs, including the always-present risk of unintended consequences, would clearly outweigh the benefits. Consistent with this principle, the Board believes that the APR threshold should satisfy two objectives. It should ensure that subprime loans are covered. Second, it should also generally exclude prime loans. The subprime market should be covered because it is, by definition, the market with the highest credit risk. There are of course variations in risk within the subprime market. For example, delinquencies on fixed-rate subprime mortgages have been lower in recent years than on adjustable-rate subprime mortgages. It may not be practical or effective, however, to target certain loans in the subprime market for coverage while excluding others. Such a rule would be more complex and possibly require frequent updating as products evolved. Moreover, market imperfections discussed in part II.C.—the subprime market's lack of transparency and potentially inadequate creditor incentives to make only loans that consumers can repay—affect the subprime market as a whole. There are two principal reasons why the Board seeks to exclude the prime market from § 226.35. First, there is limited evidence that the problems addressed in § 226.35, such as lending without regard to repayment ability, have been significant in the prime market or gone unaddressed when they have on occasion arisen. By nature, loans in the prime market have a lower credit risk, as seen in the relatively low default and delinquency rates for prime loans compared to sharply increasing rates for subprime loans since 2005. Moreover, the prime market is more transparent and competitive, characteristics that make it less likely a creditor can sustain an unfair, abusive, or deceptive practice. In addition, borrowers in the prime market are less likely to be under the degree of financial stress that tends to weaken the ability of many borrowers in the subprime market to protect themselves against unfair, abusive, or deceptive practices. To be sure, there have been concerns about the prime market, and this proposal would address some of them. For example, the proposal addresses concerns about coercion of appraisers, untransparent creditor payments to mortgage brokers, and abusive servicing practices. Second, any undue risks to consumers in the prime market from particular loan terms or lending practices can be adequately addressed through means other than new regulations under HOEPA. Supervisory guidance from the federal agencies influences a large majority of the prime market which, unlike the subprime market, has been dominated by federally supervised institutions. 42 Such guidance affords regulators and institutions alike more flexibility than a regulation, with potentially fewer unintended consequences. In addition, the Government Sponsored Enterprises continue to play a major role in the prime market, and they are accountable to regulators and policy makers for the standards they set for loans they will purchase. 43 42 According to HMDA data from 2005 and 2006, more than three-quarters of prime, conventional first-lien mortgage loans on owner-occupied properties were made by depository institutions or their affiliates. For this purpose, a loan for which price information was not reported is treated as a prime loan. 43 According to HMDA data from 2005 and 2006, nearly 30 percent of prime, conventional first-lien mortgage loans on owner-occupied properties were purchased by Fannie Mae or Freddie Mac. For these reasons, the Board does not believe that substantive restrictions on loan terms or lending practices are warranted in the prime market at this time. The need for such restrictions is not clear and their potential unintended consequences could be significant. Inherent Uncertainty of Meeting Coverage Objectives There are three major reasons why it is inherently uncertain which APR threshold would achieve the twin objectives of covering the subprime market and generally excluding the prime market. First, there is no single, precise, and uniform definition of the prime or subprime market, or of a prime or subprime loan. Moreover, the markets are separated by a somewhat loosely defined segment known as the alt-A market, the precise boundaries of which are not clear. Second, available data sets enable only estimation, not precise calculation, of the empirical relationship between APR and credit risk. A proprietary dataset such as First American LoanPerformance may contain detailed information on loan characteristics, including the contract rate, but lack the APR or sufficient data to derive the APR. Other data must be consulted to estimate APRs based on contract rates. HMDA data contain the APR for higher-priced loans (as adjusted by comparable Treasury securities), but they have little information about credit risk. Third, data sets can of course show only the existing or past distribution of loans across market segments, which may change in ways that are difficult to predict. In particular, the distribution could change in response to the Board's imposition of the restrictions in § 226.35, but the likely direction of the change is not clear. A loan's APR is typically not known to a certainty until after the underwriting has been completed, and not until closing if the consumer has not locked the interest rate. Creditors might build in a “cushion” against this uncertainty by voluntarily setting their internal thresholds lower than the threshold in the regulation. Creditors would have a competing incentive to avoid the restrictions, however, by restructuring the prices of potential loans that would have APRs just above the threshold to cause the loans' APRs to come under the threshold. Different combinations of interest rate and points that are economically identical for an originator produce different APRs. If proposed § 226.35 were adopted, an originator would have an incentive to achieve a rate-point combination that would bring a loan's APR below the threshold (if the borrower had the resources or equity to pay the points). Moreover, some fees, such as late fees and prepayment penalties, are not included in the APR. Creditors could increase the number or amounts of such fees to maintain a loan's effective price while lowering its APR below the threshold. It is not clear whether the net effect of these competing forces of over-compliance and circumvention would be to capture more, or fewer, loans. For all of the above reasons, there is inherent uncertainty as to what APR threshold would achieve the objectives of covering the subprime market and generally excluding the prime market. The Alt-A Market In the face of this uncertainty, deciding on an APR threshold calls for judgment. The Board believes it may be appropriate to err on the side of covering somewhat more than the subprime market. In effect, this could mean covering part of the alt-A market, a possibility that merits special consideration. The alt-A market is generally understood to be for borrowers who typically have higher credit scores than subprime borrowers but still pose more risk than prime borrowers because they make small down payments or do not document their incomes, or for other reasons. The definition of this market is not precise, however. Moreover, the size and character of this market segment have changed markedly in a relatively short period. According to one source, it was 2 percent of residential mortgage originations in 2003 and 13 percent in 2006. 44 At least part of this growth was due to increasing flexibility of underwriting standards. For example, in 2006, 80 percent of loans originated for alt-A securitized pools were underwritten without full documentation of income, compared to about 60 percent from 2000 to 2004. 45 At the same time, nontraditional mortgages allowing borrowers to defer principal, or both principal and interest, also expanded, reaching 78 percent of alt-A originations in 2006. 46 44 *IMF 2007 Mortgage Market* , at 4. 45 Figures calculated from First American LoanPerformance data. 46 David Liu & Shumin Li, *Alt A Credit—The Other Shoe Drops?* , The MarketPulse The MarketPulse (First American LoanPerformance, Inc., San Francisco, Cal.), Dec. 2006. The Board recognizes that risks to consumers in the alt-A market are lower than risks in the subprime market. The Board believes, however, that it may be appropriate to cover at least part of the alt-A market with the protections of § 226.35. Because of the inherent uncertainties in setting an APR threshold discussed above, covering part of the alt-A market may be necessary to ensure consistent coverage of the subprime market. Moreover, to the extent § 226.35 were to cover the higher-priced end of the alt-A market, where several risks may be layered, the regulation may benefit consumers more than it would cost them. For example, applying an income verification requirement to the riskier part of the alt-A market could ameliorate injuries to consumers from lending based on inflated incomes without necessarily depriving consumers of access to credit, if they are able to document their incomes as § 226.35(b)(2) would require. Prohibiting lending without regard to repayment ability in this market slice could reduce the risk to consumers from “payment shock” on nontraditional loans. At the same time, the Board recognizes the potential for unintended consequences if § 226.35 restrictions were to cover part of the alt-A market and seeks to minimize those consequences. The Proposed Thresholds of 3 and 5 Percentage Points Based on the foregoing considerations, the Board is proposing to set the APR threshold for a loan at three percentage points above the comparable Treasury security, or five percentage points in the case of a subordinate-lien loan. Available data indicate that this threshold would capture the subprime market but generally exclude the prime market. In each of the last two years, the percentage of the first-lien mortgage market Regulation C has captured as higher-priced using a threshold of three percentage points has been greater than the percentage of the total market originations that one industry source has estimated to be subprime (25 percent vs. 20 percent in 2005; 28 percent vs. 20 percent in 2006). 47 Regulation C is not thought, however, to have reached the prime market. Rather, in both years it reached into the alt-A market, which the same source estimated to be 12 percent in 2005 and 13 percent in 2006. In 2004, Regulation C captured a significantly smaller part of the market than an industry estimate of the subprime market (11 percent vs. 19 percent), but that year's HMDA data were somewhat anomalous. 48 47 For industry estimates see *IMF 2007 Mortgage Market* , at 4. 48 The principal cause of the reporting deficit was the unusually steep yield curve that characterized 2004. For purposes of proposed § 226.35(a), the Board is proposing to adjust the method that Regulation C uses to calculate the higher-priced loan threshold to reduce, though not eliminate, the effects of yield curve changes on § 226.35's coverage. This proposal is discussed below. The Board does not have data indicating how closely the proposed threshold of five percentage points for subordinate-lien loans would correspond to the subprime home equity market. It is the Board's understanding, however, that this threshold, which has prevailed in Regulation C since 2004, has been at least roughly accurate. Requests for Comment The Board seeks comment, and supporting data, on whether different thresholds would better satisfy the objectives of covering the subprime market and generally excluding the prime market. The Board seeks comment and data both as to first-lien loans and as to subordinate-lien loans; and both as to home purchase loans and as to refinancings. The Board also seeks comment and supporting data on the extent to which the proposed threshold would cover the alt-A market and, as discussed above, on the costs and benefits of such coverage. Moreover, the Board seeks comment on whether a different threshold than that proposed, such as four percentage points for first-lien loans (and six percentage points for subordinate-lien loans), would better satisfy the objectives of covering the subprime market, excluding the prime market, and avoiding unintended consequences for consumers in the alt-A market. The Board also seeks comment on the extent to which lenders may set an internal threshold lower than that set forth in the regulation to ensure compliance, and the consequences that could have for consumers. Conversely, the Board seeks comment on the extent of the risk creditors would circumvent the proposed restrictions by charging more fees and lower interest rates to reduce their loans' APRs, and the consequences that could have for consumers. Is this risk significant enough to warrant addressing separately. For example, should the Board adopt a separate fee trigger? What fees would such a trigger include and at what level would it be set? Alternatively, would a general prohibition on manipulating the APR to circumvent the protections of § 226.35 be practicable? F. Mechanics of the Proposed APR Trigger Under Regulation C, price information on a closed-end, first-lien loan is reported if the loan's APR exceeds by three or more percentage points (five if the loan is secured by a subordinate lien) the yield on Treasury securities having a comparable period of maturity. A lender uses the yield on Treasury securities as of the 15th day of the preceding month if the rate is set between the 1st and the 14th day of the month, and as of the 15th of the current month if the rate is set on or after the 15th day. Although the Board proposes to use the same numerical thresholds, the Board proposes to use somewhat different rules for matching mortgage loans to Treasury securities. Matching Loans to Treasury Securities For purposes of this rulemaking, the Board proposes to use a different approach than Regulation C uses to match loans to Treasury securities, with the intent of reducing effects solely from changes in the interest rate environment. Following the model of HOEPA (TILA Section 103(aa), 15 U.S.C. 1603(aa)), Regulation C compares the APR on a loan to the yield on Treasury securities having a period of maturity comparable to the maturity of the loan. 12 CFR 203.4(a)(12). For example, the APR on a fixed-rate, 30-year loan—the most common loan term in the market—is compared to the yield on a 30-year Treasury security. In actuality, mortgage loans are usually paid off long before they mature, typically in five to ten years. Rates on fixed-rate 30-year mortgage loans, therefore, more closely track yields on Treasury securities having maturities in the range of five to ten years rather than yields on 30-year Treasury securities. Rates on adjustable-rate mortgages more closely track yields on Treasury securities that mature in one to five years, depending in part on the duration of any initial fixed-rate period. As a result, changes in the relationship of short-term rates to long-term rates, known as the yield curve, have affected reporting of higher-priced mortgage loans. For purposes of the rules proposed here, the Board's goal is to reduce this “yield curve effect.” Ideally, each loan would be matched to a Treasury security that corresponds to that loan's expected maturity, which would be determined based on empirical data about prepayment speeds for loans with the same features. It is not practicable, however, to match loans to Treasuries on the basis of the full range of features that may influence prepayment speeds. For the sake of simplicity and predictability, the Board proposes to prescribe rules based on three features: whether the loan is adjustable-rate or fixed-rate; the term of the loan; and the length of any initial fixed-rate period, if the loan is adjustable-rate. Proposed § 226.35(a) that would match closed-end loans to Treasury securities as follows. First, variable rate transactions with an initial fixed-rate period of more than one year would be matched to Treasuries having a maturity closest to the length of the fixed-rate period (unless the fixed-rate period exceeds seven years, in which case the creditor would use the rules applied to non-variable rate loans). For example, a 30-year ARM having an initial fixed-rate period of five years would be matched to a 5-year Treasury security. Second, variable-rate transactions with an initial fixed-rate period of one year or less would be matched to Treasury security having a maturity of one year. Third, fixed-rate loans would be matched on the basis of loan term in the following way: A fixed-rate loan with a term of 20 years or more would be matched to a 10-year Treasury security; a fixed-rate loan with a term of more than 7 years but less than twenty years would be matched to a 7-year Treasury security; and a fixed-rate loan with a term of seven years or less would be matched to the Treasury security with a maturity closest to the term. Timing of the Match The proposal also would differ from Regulation C as to timing. The Treasury security yield that would be used is the yield as of the 15th of the month preceding the month in which the application is received, rather than the 15th of the month before the rate is locked. This would introduce more certainty, earlier in the application process, to the determination as to whether a potential transaction would be a higher-priced mortgage loan when consummated. The actual APR, however, would not be known to a certainty early in the application process, leaving some uncertainty as to whether a potential loan will be a higher-priced loan if it is actually originated. The APR disclosed within three days of application could change before closing for legitimate reasons such as changes in the interest rate or in the borrower's decision as to how many points to pay, if any. It is not expected, however, that an APR would change substantially in many cases for legitimate reasons. Using two different trigger dates in Regulation C and Regulation Z § 226.35(a)—the rate lock date in the first and the application date in the second—could increase regulatory burden. Using the rate lock date in § 226.35(a), however, could increase uncertainty, relative to using the application date, as to whether a loan would be higher-priced when consummated. The Board believes the potentially somewhat higher regulatory burden from inconsistency may be justified by the increase in certainty. Requests for Comment The Board seeks data with which to evaluate the proposed approach to matching mortgage loans to Treasury securities and the proposal to select the appropriate Treasury security based on the application date. The Board also solicits suggestions for alternative approaches that would better meet the objectives of relative simplicity and reasonably accurate coverage. VII. Proposed Rules for Higher-Priced Mortgage Loans—§ 226.35 A. Overview This part discusses the new consumer protections the Board proposes to apply to “higher-priced mortgage loans.” A creditor would be prohibited from engaging in a pattern or practice of making higher-priced mortgage loans based on the collateral without regard to repayment ability. A creditor would also be prohibited from making an individual higher-priced mortgage loan without: Verifying the income and assets the creditor relied upon to make the loan; and establishing an escrow account for taxes and insurance. In addition, a higher-priced mortgage loan could not have a prepayment penalty except under certain conditions. The Board believes that the practices that would be prohibited, when conducted in connection with higher-priced mortgage loans, are unfair, deceptive, associated with abusive lending practices, and otherwise not in the interest of the borrower. *See* TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), and the discussion of this statute in part V above. Making higher-priced mortgage loans without adequately considering repayment ability, verifying income or assets, or establishing an escrow account for taxes and insurance significantly increases the risk that consumers will not be able to repay their loans. When consumers cannot repay their loans and must choose between losing their homes and refinancing in an effort to stay in their homes, they are more vulnerable to such abuses as loan flipping and equity stripping. Prepayment penalties in certain circumstances can exacerbate these injuries by making it more costly to exit unaffordable loans. The Board has considered that some of the practices that would be prohibited may benefit some consumers in some circumstances. As discussed more fully below with respect to each prohibited practice, however, the Board believes that in connection with higher-priced mortgage loans these practices are likely to cause more injury to consumers than any benefit the practices may provide them. The Board has also considered that the proposed rules may reduce the access of some consumers in some circumstances to legitimate and beneficial credit arrangements, either directly as a result of a prohibition or indirectly because creditors may incur, and pass on, increased compliance and litigation costs. The Board believes the benefits of the proposal outweigh these costs. The Board has also considered other, potentially less burdensome, approaches such as requiring more, or better, disclosures. For reasons discussed in part II.C., the Board believes that disclosures alone may not provide consumers in the subprime market adequate protection from unfair, deceptive, and abusive lending practices. The discussion below sets forth additional reasons why disclosures and other possible alternatives to the proposed prohibitions may not give adequate protection. In addition to proposing new protections for consumers with higher-priced mortgage loans, the Board is also proposing to prohibit a creditor from structuring a closed-end mortgage loan as an open-end line of credit for the purpose of evading the restrictions on higher-priced mortgage loans, which do not apply to open-end lines of credit. This proposal is based on the authority of the Board under TILA Section 129(l)(2) to prohibit practices that would evade Board regulations adopted under authority of that statute. 15 U.S.C. 1639(l)(2). B. Disregard of Consumers' Ability to Repay—§§ 226.34(a)(4) and 226.35(b)(1) TILA Section 129(h), 15 U.S.C. 1639(h), and Regulation Z § 226.34(a)(4) currently prohibit a pattern or practice of extending HOEPA loans based on consumers' collateral without regard to their repayment ability. HOEPA loans are, however, a very small portion of the subprime market. The Board is proposing to extend the prohibition against a pattern or practice of lending based on consumers' collateral without regard to their repayment ability to higher-priced mortgage loans as defined in § 226.35(a). The prohibition in § 226.34(a)(4) would be revised somewhat, and this revised prohibition would be incorporated as proposed new § 226.35(b)(1). Public Comment on Determining Ability To Repay In the Board's June 14, 2007 hearing notice, the Board solicited comment on the following alternatives to ensure borrowers' repayment ability: • Should lenders be required to underwrite all loans based on the fully-indexed rate and fully amortizing payments? • Should there be a rebuttable presumption that a loan is unaffordable if the borrower's debt-to-income
(DTI)ratio exceeds 50 percent? • Are there specific consumer disclosures that would help address concerns about unaffordable loans? Few commenters offered specific disclosure suggestions but many commenters and hearing witnesses addressed the first two questions. Most consumer and community groups who commented support a requirement to underwrite ARMs using the fully-indexed, fully-amortizing rate. Several recommended, however, that the Board require underwriting to the maximum rate possible or, at least, to a rate higher than the fully-indexed rate. These commenters are concerned that using the fully-indexed rate would not adequately assure repayment ability because indexes can increase. All of the financial institutions and financial services trade groups who responded to the question agree that underwriting a loan based on its fully-indexed interest rate and fully-amortizing payment is generally prudent. With few exceptions, however, most of these commenters oppose codifying such a standard in a regulation, arguing that a regulation would be too rigid, constrain lenders from relying on their own experience and judgment, and make ARMs unavailable to many subprime borrowers. Several financial institutions and trade groups asked that any fully-indexed rate requirement the Board adopts be limited to ARMs with introductory fixed-rate periods of less than five years. They maintained that most borrowers having ARMs with longer fixed-rate periods refinance before the rate adjusts. Consumer and community groups argue that a requirement to underwrite to the fully-indexed rate would not assure that loans would be affordable unless the Board also specified a maximum debt-to-income
(DTI)ratio. Most groups stated that a maximum 50 percent DTI ratio would be an appropriate threshold to identify presumptively unaffordable loans. On the other hand, the vast majority of the financial institution and industry trade group commenters oppose adoption of a maximum DTI ratio. Some stated the DTI ratio is not one of the most important predictors of loan performance. Others noted the difficulties of clearly defining “debt” and “income” for purposes of such a rule, or of clearly defining mitigating factors such as high credit scores. Some identified categories of borrowers for whom high DTIs are not inappropriate, such as high-income borrowers; borrowers with substantial assets; and borrowers refinancing or consolidating loans with even higher payment burdens. Discussion *Recent evidence of disregard for repayment ability.* Subprime loans are expected to default at higher rates than prime loans because they generally are made to higher-risk borrowers. But the high frequency of so-called 2-28 and 3-27 ARMs in subprime originations in recent years—and the recent rapid and significant increase in serious delinquencies and foreclosures among such loans originated from 2005 to early 2007, including within several months of closing—have raised serious questions as to whether originators have paid adequate attention to repayment ability. Approximately three-quarters of securitized originations in subprime pools from 2004 to 2006 were of 2-28 or 3-27 ARMs, or ARMs with interest rates discounted for two or three years and fully-indexed afterwards. In a typical case of a 2-28 discounted ARM, a $200,000 loan with a discounted rate of 7 percent for two years (compared to a fully-indexed rate of 11.5 percent) and a 10 percent maximum rate in the third year would start at a payment of $1,531 and jump to a payment of $1,939 in the third year, even if the index value did not increase. The rate would reach the fully-indexed rate in the fourth year (if the index value still did not change), and the payment would increase to $2,152. 49 49 This example is taken from the federal agencies' proposed subprime illustrations. Proposed Illustrations of Consumer Information for Subprime Mortgage Lending, 72 FR 45495, 45497 n.2 & 45499, Aug. 14, 2007. The example assumes an initial index of 5.5 percent and a margin of 6 percent; assumes annual payment adjustments after the initial discount period; a 3 percent cap on the interest rate increase at the end of year 2; and a 2 percent annual payment adjustment cap on interest rate increases thereafter, with a lifetime payment adjustment cap of 6 percent (or a maximum rate of 13 percent). In recent years many subprime lenders did not consider adequately whether borrowers would be able to afford the higher payment, and appeared instead to assume that borrowers would be able to refinance notwithstanding their very limited equity. Originators extended some 2-28 ARMs from 2005 to early 2007 without having reason to believe the borrower would be able to afford the payment after reset. Originators may have assumed that these borrowers would refinance before reset, an assumption that proved unrealistic, at least under newly tightened lending standards, when house prices fell and the borrowers could not accumulate enough equity to refinance. In fact, some 2-28 ARMs originated in 2005 and 2006 appear to have been made to borrowers who could not afford even the initial payment. Over 10 percent of the 2-28 ARMs originated in 2005 appear to have become seriously delinquent before their first reset. 50 While some borrowers may have been able to make their payments—they stopped making payment because the values of their houses declined and they lost what little equity they had—others may not have been able to afford even their initial payments. 50 Figure calculated from First American LoanPerformance data. *Potential reasons for unaffordable loans.* There are several reasons why borrowers, especially in the subprime market, would accept loans they would not be able to repay. In some cases, less scrupulous originators may mislead borrowers into entering into unaffordable loans by understating the payment before closing and disclosing the true payment only at closing. At the closing table, many borrowers may not notice the disclosure of the payment or have time to consider it; or they may consider it but feel constrained to close the loan. This constraint may arise from a variety of circumstances. For example, the borrower may have signed agreements to purchase a new house and to sell the current house. Or the borrower may need to escape an overly burdensome payment on a current loan, or urgently need the cash that the loan will provide for a household emergency. In the subprime market in particular, consumers may accept loans knowing they may have difficulty affording the payments because they do not have reason to believe a more affordable loan would be available to them. Possible sources of this behavior, including the limited transparency of prices, products, and broker incentives in the subprime market, are discussed in part II.C. Borrowers who do not expect any benefit from shopping further, which can be costly, make a reasoned decision not to shop and to accept the terms they believe are the best they can get. Furthermore, borrowers' own assessment of their repayment ability may be influenced by their belief that a lender would not provide credit to a consumer who did not have the capacity to repay. Borrowers could reasonably infer from a lender's approval of their applications that the lender had appropriately determined that they would be able to repay their loans. Borrowers operating under this impression may not independently assess their repayment ability to the extent necessary to protect themselves from taking on obligations they cannot repay. Borrowers are likely unaware of market imperfections that may reduce lenders' incentives to fully assess repayment ability. *See* part II.C. In addition, lenders and brokers may sometimes encourage borrowers to be excessively optimistic about their ability to refinance should they be unable to sustain repayment. For example, they sometimes offer reassurances that interest rates will remain low and house prices will increase; borrowers may be swayed by such reassurances because they believe the sources are experts. *Injuries from unaffordable loans.* When borrowers cannot afford to meet their payment obligations, they and their communities suffer significant injury. Such borrowers are forced to use up home equity or other assets to cover the costs of refinancing. If refinancing is not an option, then borrowers must make sacrifices to keep their homes. If they cannot keep their homes, then they must sell before they had planned or endure foreclosure and eviction; in either case they may owe the lender more than the house is worth. If a neighborhood has a concentration of unaffordable loans, then the entire neighborhood may endure a decline in homeowner equity. Moreover, if disregard for repayment ability contributes to a rise in delinquencies and foreclosures, as appears to have happened recently, then the credit tightening that may follow can injure all consumers who are potentially in the market for a mortgage loan. *Potential benefits.* There does not appear to be any benefit to consumers from loans that are clearly unaffordable at origination or immediately thereafter. The Board recognizes, however, that some consumers may in some circumstances benefit from loans whose payments would increase significantly after an initial period of reduced payments. For example, some consumers may expect to be relocated by their employers and therefore intend to sell their homes before their payment would increase significantly. Moreover, a planned increase in the payment that would not be affordable at consumers' current incomes (as of consummation) may be affordable at the incomes consumers can document that they reasonably expect to earn when the payment increases. The proposal described below is intended to provide sufficient flexibility to creditors to ensure that credit would be available under such circumstances. Consumers may also benefit from loans with payments that could increase after an initial period of reduced payments if they have a realistic chance of refinancing, before the payment burden increases substantially, into lower-rate loans that were more affordable on a longer-term basis. This benefit is, however, quite uncertain, and it is accompanied by substantial risk. Consumers would have to both improve their credit scores sufficiently and accumulate enough equity to qualify for lower-rate loans. Concerns about the affordability after reset of 2-28 and 3-27 ARMs originated from 2005 to early 2007 illustrate the hazards of counting on both developments occurring before payments become burdensome. Marketed as “affordability products,” these loans often were made with high loan-to-value ratios on the assumption that house prices would appreciate. In areas where house price appreciation slowed or prices declined outright, the assumption proved unreliable. Moreover, the Board is not aware of evidence on the proportion of such borrowers who were actually able to raise their credit scores enough to qualify for lower-rate loans had they accumulated sufficient equity. In short, evidence from recent events is consistent with a conclusion that a widespread practice of making subprime loans with built-in payment shock after a relatively short period on the basis of assuming consumers will accumulate sufficient equity and improve their credit scores enough to refinance before the shock sets in can cause consumers more injury than benefit. The Proposed Prohibition HOEPA and § 226.34 prohibit a lender from engaging in a pattern or practice of extending credit subject to § 226.32 (HOEPA loans) to a consumer based on the consumer's collateral without regard to the consumer's repayment ability, including the consumer's current and expected income, current obligations, and employment. Under the proposal, the prohibition in § 226.34(a)(4) would be revised to clarify and strengthen it. The revised § 226.34(a)(4) would be incorporated into § 226.35(b) as one of the restrictions that apply to higher-priced mortgage loans. Higher-priced mortgage loans would be defined in § 226.35(a) as explained above. As proposed, Regulation Z would prohibit a lender from engaging in a pattern or practice of making higher-priced mortgage loans based on the value of consumers' collateral without regard to consumers' repayment ability as of consummation, including consumers' current and reasonably expected income, current and reasonably expected obligations, employment, and assets other than the collateral. Each of the elements of this proposed standard is discussed below. *Collateral-based lending.* The proposal would prohibit a pattern or practice of collateral-based lending with higher-priced mortgage loans. The Board recognizes that this proposal may reduce the availability of credit for consumers whose current and expected income and non-collateral assets are not sufficient to demonstrate repayment ability. For example, unemployed borrowers with limited assets apart from their homes may have more difficulty obtaining mortgage credit under this proposal if their combined risk factors are high enough that the APR of their potential loan would exceed the proposed threshold in § 226.35(a). *“Pattern or practice.”* The Board is not proposing to prohibit making an individual loan without regard to repayment ability, either for HOEPA loans or for higher-priced mortgage loans. Instead, the Board is proposing to retain the pattern or practice element in the prohibition, and to include that element in the proposed new prohibition for higher-priced mortgage loans. The “pattern or practice” element of the prohibition is intended to balance potential costs and benefits of the rule. Creating civil liability for an originator that fails to assess repayment ability on any individual loan could inadvertently cause an unwarranted reduction in the availability of mortgage credit to consumers. The “pattern or practice” element is intended to reduce that risk while helping prevent originators from making unaffordable loans on a scale that could cause consumers substantial injury. Whether a creditor had engaged in the prohibited pattern or practice would depend on the totality of the circumstances in the particular case, as explained in an existing comment to § 226.34(a)(4). The comment further indicates that while a pattern or practice is not established by isolated, random, or accidental acts, it can be established without the use of a statistical process. It also notes that a creditor might act under a lending policy (whether written or unwritten) and that action alone could establish a pattern or practice of making loans in violation of the prohibition. The Board is not proposing to adopt a quantitative standard for determining the existence of a pattern or practice. Nor does it appear feasible for the Board to give examples, as the inquiry depends on the totality of the circumstances. Comment is sought, however, on whether further guidance would be appropriate and specific suggestions are solicited. *“Current and expected income.”* The statute and regulation both prohibit a creditor from disregarding a consumer's repayment ability, including current and expected income. The Board proposes to retain the references to expected and current income, and to clarify that expectations of income must be reasonable. The Board believes consumers may benefit if a creditor is permitted to take into account reasonably expected increases in income. For example, a consumer seeking a professional degree or certificate may, depending on the job market and other relevant circumstances, reasonably anticipate an increase in income after obtaining the degree or certificate. Under the proposal, a creditor could consider such an increase. For consumers who do not have a current income and cannot demonstrate a reasonable expectation of income, creditors may consider assets other than the collateral. *Other proposed clarifications.* Several other revisions are proposed for clarity. The phrase “as of consummation” would be added to make clear that the prohibition is based on the facts and circumstances that existed as of consummation. Under proposed comment 34(a)(4)-2, events after consummation, such as an unusually high default rate, may be relevant to determining whether a creditor has violated § 226.34(a)(4), but events after consummation do not, by themselves, establish a violation. The comment would provide the following example: a violation is not established if borrowers default after consummation because of serious illness or job loss. In addition, to clarify the basis for determining repayment ability the regulation and existing comments would be revised, and new comments would be added. First, comment 34(a)(4)-1 (renumbered as 34(a)(4)-3) would be revised to clarify the regulation's reference to employment as a factor in determining repayment ability. The comment would indicate that in some circumstances it may be appropriate or necessary to take into account expected changes in employment. For example, depending on all of the facts and circumstances, it may be reasonable to assume that students obtaining professional degrees or certificates will obtain employment upon receiving the degree or certificate. Second, the regulation would be revised to refer not just to current obligations but also to expected obligations. This would make the reference to obligations parallel to the statute and regulation's references to current and expected income. Proposed comment 34(a)(4)(i)(A)-2 would clarify that, where two different creditors are extending loans simultaneously to the same consumer, one a first-lien loan and the other a subordinate-lien loan, each creditor would generally be expected to verify the obligation the consumer is undertaking with the other creditor. A pattern or practice of failing to do so would create a presumption of a violation. Third, the revised regulation would make clear that creditors may rely on assets other than the collateral to determine repayment ability. An existing comment would be revised to give these examples: A savings accounts or investments that can be used by the consumer. The Board believes it is appropriate for lenders to consider non-collateral assets such as these in determining repayment ability, and for consumers to be free to substitute assets for income in meeting their obligations. Fourth, minor revisions would be made to § 226.34(a)(4) solely for clarity. The term “consumer” in the regulation would be put in the plural, “consumers,” to reflect that the prohibition concerns a pattern or practice. The phrase “based on consumers' collateral” would be revised to read “based on the value of consumers' collateral.” No change in meaning is intended. Proposed Presumptions Section 226.34(a)(4) contains a provision creating a rebuttable presumption of a violation where a lender engages in a pattern or practice of failing to verify and document repayment ability. The proposed regulation would retain this presumption, which would be incorporated in proposed § 226.35(b)(1). The Board is also proposing to add new, rebuttable presumptions to § 226.34(a)(4) and, by incorporation, § 226.35(b)(1). These would be presumptions of a violation for engaging in a pattern or practice of failing to consider: consumers' ability to pay the loan based on the interest rate specified in the regulation (§ 226.34(a)(4)(i)(B)); consumers' ability to make fully-amortizing loan payments that include expected property taxes and homeowners insurance (§ 226.34(a)(4)(i)(C)); the ratio of borrowers' total debt obligations to income as of consummation (§ 226.34(a)(4)(i)(D)); and borrowers' residual income (§ 226.34(a)(4)(i)(E)). A new comment 34(a)(4)(i)-1 would clarify that the presumption for failing to verify income as well as the proposed new presumptions would be rebuttable by the lender with evidence that the lender did not disregard repayment ability. The comment would also clarify that the presumptions are not exhaustive. That is, a creditor may violate § 226.34(a)(4) (or § 226.35(b)(1)) by patterns or practices other than those specified in paragraph 34(a)(4)(i). Each of the proposed presumptions is discussed in turn below. Comment is sought generally on the appropriateness of the proposed presumptions, and on whether additional presumptions should be adopted. *Failure to verify* . Section 226.34(a)(4) contains a provision creating a rebuttable presumption of a violation where a lender engages in a pattern or practice of failing to verify and document repayment ability. The proposed regulation would retain this presumption, though it would be placed, along with other proposed new presumptions, in new sub-paragraph
(i)of § 226.34(a)(4). It would also be revised to refer explicitly to the aspects of repayment ability identified in § 226.34(a)(4), namely, borrower's current and reasonably expected income and assets, current and reasonably expected obligations, and employment. It would also refer to the verification requirements stated in § 226.35(b)(2)(i). Under § 226.35(b)(2), a lender would be required to verify amounts the lender relies on by the consumer's Internal Revenue Service Form W-2, tax returns, payroll receipts, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer's income and assets. *See* part VII.C. A new comment would clarify that a pattern or practice of failing to verify obligations would also trigger a presumption of a violation. It would indicate, however, that a credit report generally may be used to verify obligations. *Ability to make fully-indexed, fully-amortizing payments* . Variable rate mortgages with discounted initial rates have become common in the subprime market. In a typical example, a loan would have an index and margin at consummation of 11.5 percent but a discounted initial rate for the first two years of 7 percent. Determining repayment ability on the basis of the initial rate would not give a realistic picture of the borrower's ability to afford the loan once the rate began adjusting according to the agreed index and margin. 51 The Board is proposing in § 226.34(a)(4)(i)(B) that a pattern or practice of failing to consider a borrower's repayment ability at the fully-indexed rate would create a presumption of a violation of § 226.34(a)(4) (or § 226.35(b)(1)). 51 As discussed in part IV above, concerns about underwriting practices for products with introductory rates or payments led the Board and the other federal supervisory agencies to issue guidance advising institutions to qualify borrowers using the fully-indexed rate and fully amortizing payments. Section 226.34(a)(4)(i)(B) would also address the case of a step-rate loan, a loan in which specific interest rate changes are agreed to in advance. For example, the parties could agree that the interest rate on the loan would be 5 percent for two years, 6 percent for two years, and 7 percent thereafter. The regulation would provide that, for such loans, a failure to consider the borrower's repayment ability at the highest interest rate possible within the first seven years of the loan's term (seven percent in the example) would create a presumption of a violation. The Board seeks comment on whether a shorter period, such as five years, would be appropriate. The Board also seeks comment on whether this presumption should be modified to accommodate loans with balloon payments and, if so, how it should be modified. *Borrower debt-to-income ratio and residual income* . The proposed presumptions of a violation for failure to consider the debt-to-income ratio (§ 226.34(a)(4)(i)(D)) or residual income ((§ 226.34(a)(4)(i)(E)) reflect the fact that this information generally is part of a responsible determination of repayment ability. Comment 34(a)(4)(i)(D)-1 would clarify, however, that the Board is not proposing a specific debt-to-income ratio that would create a presumption of a violation; nor is the Board proposing a specific ratio that would be a safe harbor. Similarly, comment 34(a)(4)(i)(E)-1 would indicate that the regulation does not require a specific level of residual income. The Board is concerned that making a specific debt-to-income ratio or residual income level either a presumptive violation or a safe harbor could limit credit availability without providing adequate off-setting benefits. These are but two of many factors that determine repayment ability. For example, depending on the circumstances, the repayment risk implied by a high debt-to-income ratio could be offset by other factors that reduce the risk, such as a high credit score and a substantial down payment. The Board is reluctant to adopt a quantitative standard for one or two underwriting factors when repayment ability depends on the totality of many inter-relating factors. It is possible, however, that adopting a quantitative standard for the debt-to-income ratio or other underwriting factors would provide at least some benefit to creditors and, by extension, consumers, by providing bright lines. The Board seeks comment on whether it should adopt a presumption of a violation, or a safe harbor, at a 50 percent debt-to-income ratio, or at a lower or higher ratio. What exceptions would be necessary for borrowers with high incomes or substantial assets, or for other cases? Comment is also sought on whether the Board should in addition, or instead, adopt quantitative standards for presumptive violations, or safe harbors, based on other underwriting factors. *Property taxes and insurance* . Section 226.34(a)(4)(i)(C) would create a separate presumption of a violation of § 226.34(a)(4) (or § 226.35(b)(1)) for a pattern or practice of failing to consider the borrower's repayment ability based on a fully-amortizing payment that includes expected property taxes, homeowners insurance, and other specified housing expenses. This is intended to address concerns that some creditors would determine a borrower's ability to repay a nontraditional loan that offered an option to defer principal or interest for several years on the basis of a payment that was non-amortizing (interest only) or negatively amortizing (less than interest). Negative amortization also can arise on variable-rate transactions with annual payment caps. The proposed presumption would encourage lenders to consider the fully-amortizing payment, as the Subprime Guidance advises lenders to do. *See* part V. The fully-amortizing payment would be based on the term of the loan. For example, the amortizing payment for a 2-28 ARM would be calculated based on a 30-year amortization schedule. Proposed Time Horizon The Board recognizes that it may not be reasonable, or to consumers' benefit, to hold creditors responsible for assuring repayment ability for the life of a loan. Most mortgage loans have terms of thirty years but prepay long before that. The Board seeks to ensure that consumers retain the ability to exchange lower initial payments for higher payments later, or for a balloon payment at the end of the loan. Accordingly, a safe harbor for creditors may be appropriate so long as it assures payments will be affordable for a reasonable time. Proposed § 226.34(a)(4)(ii) would provide that a creditor does not violate § 226.34(a)(4) if the creditor has a reasonable basis to believe that consumers will be able to make loan payments for at least seven years, considering each of the factors identified in § 226.34(a)(4)(i) (such as the fully-indexed rate and the fully-amortizing payment schedule) and any other factors relevant to determining repayment ability. This proposal is not intended to preclude creditors from offering loans with substantial payment increases before seven years. If such loans fell outside of the safe harbor, they could nonetheless be justified in appropriate circumstances. For example, a consumer with a documented intent to sell the home within three years may reasonably choose a loan with a substantial payment increase in the third year. The Board seeks comment, however, on whether specifying a shorter time horizon, such as five years, would be appropriate. General Request for Comment In addition to the specific requests for comment stated above, the Board seeks comment on whether proposed §§ 226.34(a)(4) and 226.35(b)(1) would ensure that creditors adequately consider repayment ability without unduly constraining credit availability. The Board seeks data and information that could help the Board evaluate the costs and benefits of the proposal as it would affect the subprime market and any portion of the alt-A market to which the proposal may apply. C. Verification of Income and Assets Relied on—§ 226.35(b)(2) Proposed § 226.35(b)(2) would prohibit creditors in a transaction subject to § 226.35(a) from relying on amounts of assets or income, including expected income, in extending credit unless the creditor verifies such amounts. Creditors who fail to verify income or assets before extending credit are given a safe harbor if they can show that the amounts of the consumer's income or assets relied on were not materially greater than what the creditor could have documented at consummation. Public Comment on Stated Income Lending In the hearing notice, the Board solicited comment on the following questions: • Whether stated income or low-documentation loans should be prohibited for certain loans, such as loans to subprime borrowers? • Whether stated income or low-documentation loans should be prohibited for higher-risk loans, for example, for loans with high loan-to-value ratios? • How a restriction on stated income or low-documentation loans would affect consumers and the type and terms of credit offered? • Whether lenders should be required to disclose to the consumer that a stated income loan is being offered and allow the consumer the option to document income? Consumer and community groups, individuals, and political officials, and some financial institutions and groups, favored greater restrictions on stated income loans for two reasons. First, some borrowers who could easily document their income have been harmed by receiving stated income loans that cost them more than a full documentation loan. According to commenters, these borrowers did not realize that they could have received a less costly loan by documenting their incomes. Second, other borrowers have been harmed when originators inflated their incomes—often without consumers' knowledge—to assure the originator would be able to make the loan or to enable the originator to make a larger loan, which might have higher payments that were less affordable to the consumer. To address these concerns, these commenters favored requiring creditors to obtain some documentation to support a consumer's statement of income or assets. Some suggested that documentation be required only for subprime loans, while others suggested it be required for all loans. In contrast, most financial institution and financial services trade group commenters opposed prohibiting stated income loans. These commenters argued that financial institutions should retain flexibility to accommodate borrowers who may have difficulty fully documenting their income, or whose credit risk profile is strong enough that their income is not used as an underwriting factor. Some of these commenters did, however, support the banking agencies' use of guidance, such as the Subprime Statement, to address any risks of stated income loans. One major mortgage lender supported limiting stated income lending in subprime loans by a new regulation, if the regulation allowed for mitigating circumstances. Discussion Until recently, large and increasing numbers of home-secured loans in the subprime market were underwritten without fully verifying the borrower's income and assets. 52 The share of “low doc” and “no doc” loan originations in the securitized subprime market rose from 20 percent in 2000, to 30 percent in 2004, to 40 percent in 2006. 53 Low and no documentation loans are more prevalent in the Alt-A market, where originations of such loans in securitized pools rose from about 60 percent in 2000-2004 to 80 percent in 2006. Not all low doc or no doc loans are stated income loans (because in some cases originators did not rely on income or assets as the source of repayment), but many are. 52 *See* U.S. Gov't Accountability Office, GAO-08-78R, *Information on Recent Default and Foreclosure Trends for Home Mortgages and Associated Economic and Market Developments* 5 (2007); Fannie Mae, Weekly *Economic Commentary* (Mar. 26, 2007). 53 Figures calculated from First American Loan Performance data. Lending based on unverified, or minimally verified, incomes or assets can be appropriate for consumers whose risk profiles justify the potential increased risk and who might otherwise have to incur a significant cost to document their incomes or assets. The practice, however, increases the risk that credit is extended on the basis of inflated incomes and assets, which, in turn, can injure not just the particular borrowers whose incomes or assets were inflated but their neighbors, as well. The practice also presents an opportunity for originators to mislead consumers who could easily document their incomes and assets into paying a premium for a stated income or stated asset loan. These concerns are addressed in turn below. *Risk of inflated incomes and assets* . There is anecdotal evidence that the incomes used in stated income loans were often inflated. 54 There is also evidence in the form of a higher rate of default for low doc and no doc loans (many of which are stated income loans) than for full documentation loans, and in the increase in the rate of default for low/no doc loans originated when underwriting standards were declining. 55 54 *See* Mortgage Asset Research Inst., Inc., *Eighth Periodic Mortgage Fraud Case Report to the Mortgage Bankers Association*
(2006)(reporting that 90 of 100 stated income loans sampled used inflated income when compared to tax return data); Fitch Ratings, *Drivers of 2006 Subprime Vintage Performance (Fitch 2006 Subprime Performance)* (November 13, 2007) (reporting that stated income loans with high combined loan to value ratios appear to have become vehicles for fraud). 55 Michelle A. Danis and Anthony Pennington-Cross, *The Delinquency of Subprime Mortgages* , Journal of Economics and Business (forthcoming 2007); *see also Fitch 2006 Subprime Performance* (stating that lack of income verification, as opposed to lack of employment or down payment verification, caused 2006 low documentation loans delinquencies to be higher than earlier vintages' low documentation loans). Stated income lending programs give originators incentives as well as opportunities to inflate an applicant's income or assets, or to encourage applicants to do so. Compensating the originator based on loan size and origination volume, common practices, may give the originator incentives to maximize loan size and origination volume at the expense of loan quality. Inflating income or assets can increase both loan size and origination volume, because it can cause a creditor to accept an application that would otherwise have been rejected or met with an offer of a smaller loan. The nature of the application process makes it possible that an applicant would not learn that the originator had inflated the applicant's income or assets. In many cases, applicants may not even know that they are obtaining stated income loans. They may have given the originator documents verifying their income and assets that the originator kept from the loan file so that the loan could be classified as “stated income, stated assets.” If an applicant has applied knowingly for a stated income or stated assets loan, the originator may fill out the financial statement on the standard application form based on information the applicant provides orally. The applicant may not review the form closely enough to detect errors in the stated income or assets, especially if seeing the form for the first time at the closing table. A consumer who detects errors at the closing table may not realize their importance or may face constraints that make it particularly difficult to walk away from the table without the loan. While some originators may inflate income without consumers' knowledge, other originators may tacitly encourage applicants to knowingly state inflated incomes and assets by making it clear that their actual incomes and assets are not high enough to qualify them for the loans they seek. Such originators may reassure applicants that this is a benign and common practice. In addition, applicants may inflate their incomes and assets on their own initiative in circumstances where the originator does not have reason to know. *Injuries from inflated income and assets* . The injuries to consumers from extending credit based on inflated incomes and assets are apparent. Borrowers whose loans are underwritten based on inflated income may receive larger loans with payments larger than they can comfortably afford and, therefore, face a higher risk of default as well as a higher risk of serious delinquency leading to foreclosure or distress sale. These risks are particularly pronounced for borrowers in the subprime market because their financial situations often are more precarious. The injuries caused by income inflation are not limited either to the particular borrowers whose incomes were inflated by the originator, nor to particular borrowers who inflated their incomes on their own. The practice can injure many other consumers, too. Inflating applicant incomes raises the risk of distress sales and foreclosures, concentrations of which can depress an entire community. Moreover, a widespread practice of inflating applicant incomes in an area with rapid house price appreciation—the kind of area where the practice may be most likely to arise—may fuel this appreciation and contribute to a “bubble.” *Undisclosed premiums* . Stated income lending also potentially injures consumers by leading them to pay more for their loans than they otherwise would. There is generally a premium for a stated income loan. An originator may not have sufficient incentive to disclose the premium on its own initiative because collecting and reviewing documents could slow down the origination process, reduce the number of loans an originator produces in a period, and, therefore, reduce the originator's compensation for the period. The risk that a consumer would not be aware of the premium may be particularly acute where products are complex, as is often true in the subprime market and was, at least until recently, true in the alt-A market due to the rapid growth of interest-only loans and option ARMs. Thus, consumers who can document income with little effort may choose not to because they are unaware of the cost of a stated income loan. Such consumers are effectively deprived of an opportunity to shop for a potentially lower-rate loan requiring full documentation. The Board recognizes that stated income lending in the subprime market may have potential benefits. It may speed credit access by several days for consumers who need credit on an emergency basis. It may save some consumers from expending significant effort to document their income, and it may provide access to credit for consumers who otherwise would not have access because they actually cannot document their income, for whatever reason. For the reasons discussed above, however, the Board believes that, within the subprime market, where risks to consumers are already elevated, the potential benefits to consumers of stated income/stated asset lending may be outweighed by the potential injury to consumers and competition. Stated-income lending is a significant part of the neighboring alt-A market, but, there too, it can raise concerns. Until the recent tightening of underwriting standards in the alt-A market, stated-income lending was increasingly layered on top of other risks, such as loan terms that permit the borrower to defer payment of interest or principal. The Board's Proposal To address the injuries to consumers from stated income loans in the higher-priced market, the Board proposes to require creditors to verify the income and assets *they rely on* with third-party documents that provide reasonably reliable evidence such as W-2 forms, tax returns, payroll receipts, or financial institution records. The rule is intended to be flexible and appropriately balance costs with benefits. The benefits of the proposal would appear to be significant. The rule should make it more difficult for any party to inflate incomes or assets on higher-priced mortgage loans and, therefore, reduce the frequency of the practice and the injuries to consumers the practice can cause. The rule also should eliminate the risk that consumers with higher-priced mortgage loans who could document income would unknowingly pay more for a loan that did not require documentation. The proposal could have costs as well. In general, the time from application to closing could be longer if an applicant were required to produce, and the creditor required to review, third party documents verifying income. Also, consumers who did not have documents verifying their income readily at hand would face the inconvenience of obtaining such documents. Another cost could be reduced access to credit for consumers who would have difficulty documenting their income. As explained further below, the Board believes the regulation is sufficiently flexible to keep these costs to reasonable levels relative to the expected benefits of the proposed rule. Five elements of the proposal are intended to reduce the costs to consumers and creditors that income verification may entail. First, the proposed rule requires that only the income or assets the creditor relies upon in approving the extension of credit be verified. For example, if a creditor does not rely on a part of the consumer's income, such as an annual bonus, in approving the extension of credit, the creditor would not need to verify the consumer's bonus. 56 56 Creditors would, however, still be prohibited from engaging in a pattern or practice of extending higher-priced mortgage loans to consumers based on the collateral without regard to repayment ability. *See* proposed § 226.35(b)(1). Consequently, creditors would not be able to evade the proposed income verification rule by consistently declining to consider income or assets. Second, the proposed rule specifically authorizes a creditor to rely on W-2 forms, tax returns, payroll receipts, and financial institution records. These kinds of documents generally have proven to be reliable sources of information about borrowers' income and assets. Moreover, most consumers can, or should be able to, produce one of these kinds of documents with little difficulty. Thus, the proposed safe harbor for relying on one of these kinds of documents should protect consumers while minimizing costs. Third, creditors may use any other third-party documents that provide reasonably reliable evidence of the borrower's income and assets. Examples of other third-party documents that provide reasonably reliable evidence of the borrower's income include check-cashing receipts or a written statement from the consumer's employer. *See* proposed comment 35(b)(2)-4. These are but examples, and a creditor may rely on third-party documents of any kind so long as they are reasonably reliable. The one kind of document that is categorically excluded is a statement only from the consumer. Fourth, the proposal is not intended to limit creditors' ability to adjust their underwriting standards for consumers who for legitimate reasons have difficulty documenting income, such as self-employed borrowers, or employed borrowers with irregular income. 57 For example, the rule would not dictate that a creditor must have at least two year's tax returns to approve an extension of credit to a self-employed borrower. As another example, if a creditor relied on a statement by an employed applicant that the applicant was likely to receive an annual bonus from the employer, the creditor could verify the statement with third-party documents showing a consumer's past annual bonuses. *See* proposed comment 35(b)(4)(i)-1. The same would hold for credit extended to employees who work on commission. 57 For depository institutions and their affiliates, safety and soundness considerations would continue to govern underwriting, as always. Fifth, creditors who have extended credit to a consumer and wish to extend new credit to the same consumer need not re-collect documents that the creditor previously collected from the consumer if the documents would not have changed since they were initially verified. *See* proposed comment 35(b)(2)(i)-4. For example, if the creditor has collected the consumer's 2006 tax return for a loan in May 2007, and the creditor makes another loan to that consumer in August 2007, the creditor may rely on the 2006 tax return. *Proposed safe harbor.* The proposed rule would contain a safe harbor for creditors who fail to verify income before extending credit if the amounts of income or assets relied on were not materially greater than the creditor could have verified when the extension of credit was consummated. *See* proposed § 226.35(b)(2)(ii) and comment 35(b)(2)(ii)-1. The proposed safe harbor would cover cases where the creditor's failure to verify income would not have altered the decision to extend credit to the consumer or the terms of the credit. Requests for Comment The Board seeks comment on whether, and in what specific circumstance, the proposed rule would reduce access to credit for certain borrowers, such as the self-employed, who may have difficulty documenting income and assets. The Board also requests comment on whether the rule could be made more flexible without undermining consumer protection. Comment on these questions is solicited both with respect to the subprime market and any part of the alt-A market that the proposed definition of “higher-priced mortgage loan” would tend to cover. Comment is also sought on the appropriateness of the proposed safe harbor, and on whether other safe harbors would be appropriate. *Potential alternatives.* The Board believes the proposed rule would provide consumers a significant new protection against lending based on income or asset inflation. It is also expected that creditors, regulators, and courts would find it relatively easy to determine compliance with the proposed rule. The Board recognizes, however, that the rule is broad in that it imposes a blanket requirement on all creditors to verify, for every higher-priced mortgage loan they originate, the income and assets they rely on, without consideration of the extent to which the risks of inflating income or assets may vary from case to case. This rule could increase costs for creditors as well as consumers. The rule is also broad in another respect: It imposes a blanket verification requirement on creditors even though consumers, themselves, may inflate their stated incomes without the creditor's knowledge. Such consumers might in some instances seek to enforce the proposed rule through civil actions. For these reasons, the Board seeks suggestions of narrower alternatives that would impose fewer costs on creditors and consumers while providing sufficient protection to consumers who may be injured, directly or indirectly, by stated income lending. For example, should the Board, instead of adopting the proposed rule, prohibit creditors and mortgage brokers from inflating incomes, influencing consumers to inflate incomes, or extending credit while having reason to believe that a consumer inflated income or was influenced to inflate income? Would a rule attempting to distinguish cases where creditors or brokers were not complicit in applicants' inflating incomes be cost-effective and practicable? If such a rule were adopted, should it provide a safe harbor for verifying income? *Subordinate-lien loans.* The Board's proposal covers both first-lien and subordinate-lien loans, but the Board requests comment on whether the proposed rule should make an exception for all subordinate-lien loans, or for subordinate-lien loans in amounts less than a specified dollar amount, or less than a specified percentage of the home's value. Requiring income and asset verification for subordinate-lien loans could in some cases increase costs without providing meaningful protection to consumers. For example, if a consumer has a record of making timely payments on a first-lien loan, then verifying income or assets for a small subordinate-lien loan—assuming the creditor relied on income or assets to make the credit decision—may not provide sufficient additional information about the borrower's ability to repay the debt to justify the cost of verification. Thus, the Board seeks suggestions for potential exemptions for subordinate-lien loans that would not undermine consumer protection. D. Prepayment Penalties—§ 226.32(d)(6) and (7); § 226.35(b)(3) Pursuant to TILA Section 129(c), a HOEPA-covered loan may not provide for a prepayment penalty unless: the borrower's debt-to-income
(DTI)ratio at consummation does not exceed 50 percent (and debt and income are verified); prepayment is not made using funds from a refinancing by the same creditor or its affiliate; the penalty term does not exceed five years from loan consummation; and the penalty is not prohibited under other applicable law. 15 U.S.C. 1639(c); *see also* 12 CFR 226.32(d)(6) and (7). The Board proposes to apply these restrictions to higher-priced mortgage loans. In addition, the Board proposes to require that the period during which a creditor may impose a prepayment penalty expire at least sixty days before the first date, if any, on which the periodic payment amount may increase under the terms of the loan. Public Comments on Prepayment Penalties In connection with its June 14, 2007 HOEPA hearing, the Board requested public comment on the following questions: • Should prepayment penalties be restricted? For example, should prepayment penalties that extend beyond the first adjustment period on an ARM be prohibited? • Would enhanced disclosure of prepayment penalties help address concerns about abuses? • How would a prohibition or restriction on prepayment penalties affect consumers and the type and terms of credit offered? Consumer and community groups generally commented that prepayment penalties are linked to higher loan costs for some borrowers. Many brokers and loan officers have at least some discretion to decide what interest rate to offer borrowers. In general, the higher the rate, the greater the compensation the lender pays the originator. Because the lender seeks to recover this compensation from the borrower, the lender prefers loans with prepayment payment penalties in case the borrower refinances the loan. Consumer and community group commenters stated that consumers shopping for home loans do not consider back-end costs such as prepayment penalties but rather focus on monthly payments or “teaser” interest rates on ARMs. In addition, they maintained that prepayment penalties discourage borrowers from refinancing unaffordable loans or cause them to lose home equity when the penalty amount is included in the principal amount of a refinance loan. Accordingly, most consumer and community groups recommended that the Board ban prepayment penalties on subprime home loans, a recommendation also made by state and local government officials and a trade group representing community development financial institutions. Consumer and community groups suggested that, at a minimum, if the Board permits prepayment penalties, it should require prepayment penalties for fixed-rate loans to expire two years after loan origination and prepayment penalties on subprime hybrid ARMs to terminate between sixty days and six months prior to the first rate adjustment on the loan. These groups stated that, although disclosures could be improved, doing so would not solve the problems associated with prepayment penalties in the subprime market. Most financial institutions and financial services trade groups recommended that the Board concentrate on improving disclosures and limit any regulation to requiring that the penalty term on a subprime hybrid ARM end before the first rate adjustment. A majority of these commenters recommended that borrowers be allowed to refinance without penalty starting sixty days prior the first reset; a few commenters recommended thirty days. These commenters stated that additional restrictions on prepayment penalties would reduce the amount of credit lenders and investors make available in the affected market. With respect to fixed-rate loans, some financial institutions and industry trade groups stated that a three-year limit on the term of a prepayment penalty would be appropriate. Some credit union trade groups recommended a maximum term, such as one or two years, for a prepayment penalty, including a penalty on a fixed-rate loan. Discussion Prepayment risk measures the possibility that a loan will be repaid before the end of the loan term. 58 Because a prepayment results in payment of the principal ahead of schedule, the lender (or secondary-market investor) must reinvest the funds at the new market rate, which may be lower than the old rate, particularly in the case of a refinancing. A lender also may incur certain fixed costs, such as payments to a mortgage broker, that the lender seeks to recover even if the loan is repaid early. Lenders generally account for the risk of prepayment in setting the interest rate on the loan, and usually in the subprime market (but only occasionally in the prime market) also account for the risk by including a prepayment penalty clause in the loan agreement. 58 Robert B. Avery, Glenn B. Canner & Robert E. Cook, *New Data Reported under HMDA and Its Application in Fair Lending Enforcement,* 2005 Fed. Reserve Bulletin 344, 368. In principle, a lender may offer a consumer a choice between a loan with a prepayment penalty and a loan that does not have a penalty but has a higher interest rate. Consumers in the subprime market who understood the potential trade-off between the interest rate and prepayment penalty might be willing to accept a contract with a prepayment penalty in exchange for a lower interest rate. For example, they may expect that they will refinance their loans after taking some time to improve their credit scores enough to qualify for a lower rate. Such consumers may be willing to accept a penalty with a term roughly equivalent to the time they expect it will take them to improve their scores. Accordingly, prepayment penalties may benefit individual borrowers in the subprime market who in certain circumstances would voluntarily choose them. Prepayment penalties may also benefit borrowers in the subprime market overall. Investors may find prepayment patterns more difficult to predict for subprime loans than for prime loans because prepayment of subprime loans depends not only on interest rate changes (as does prepayment of prime loans) but also on changes to borrowers' credit profiles that affect their chances of qualifying for a lower-rate loan. To the extent that penalties make the cash flow from investments backed by subprime mortgage more predictable, the secondary market may become more liquid. A more liquid secondary market may benefit borrowers by lowering interest rates and increasing credit availability. Prepayment penalties, however, also impose substantial costs on borrowers that may not be clear to them. These penalties can prevent borrowers who cannot afford to pay the penalty, either in cash or from home equity, from exiting unaffordable or high-cost loans. Moreover, borrowers who refinance and pay a penalty decrease their home equity and increase their loan balance if they finance the penalty into the new loan—as is likely if they are refinancing because of financial distress. The loss of home equity and the payment of interest on the financed penalty amount are particularly concerning if the refinance loan represents a loan “flipping” abuse. The injuries prepayment penalties may cause consumers are particularly concerning because of serious questions as to whether borrowers knowingly accept the risk of such injuries. Current disclosures of prepayment penalties, including the disclosure of penalties in Regulation Z § 226.18(k), do not appear adequate to ensure transparency. Moreover, a Federal Trade Commission report concluded, based on consumer testing, that even an improved disclosure of the prepayment penalty left a substantial portion of the prime and subprime consumers interviewed without a basic understanding of the penalty. 59 It is questionable whether consumers can accurately factor a contingent cost such as a prepayment penalty into the price of a loan; unlike the interest rate and points, a prepayment penalty is not included in the APR. 59 *Improving Mortgage Disclosures,* at 110. The lack of transparency is particularly troubling when originators have incentives to impose prepayment penalty clauses on consumers without giving them a genuine choice. Individual originators may be able to earn larger commissions or yield spread premiums on subprime loans by securing loan agreements with penalties, which increase a lender's certainty of recouping from the consumer its payment to the originator. Originators may seek to impose prepayment penalty clauses on consumers simply to increase their own compensation. This risk appears particularly high in the subprime market, where most loans have had prepayment penalties and borrowers may not have had a realistic opportunity to negotiate for a loan without a penalty. The Board plans to use consumer testing to improve the disclosure of prepayment penalties as part of its ongoing review of closed-end TILA rules, but the Board recognizes that disclosure has its limits. The prepayment penalty may be a term that highlights those limits. It is complicated for borrowers to process and of secondary importance to them compared to other loan terms. Accordingly, the Board is proposing to restrict prepayment penalties on higher-priced mortgage loans. The Board's Proposal—In General The Board proposes to apply HOEPA's prepayment penalty restrictions to a broader segment of the market, higher-priced mortgage loans, and to add a new restriction for mortgages whose payments may increase, such as ARMs. A HOEPA—covered loan may not provide for a prepayment penalty unless: the borrower's DTI ratio at consummation does not exceed 50 percent (and debt and income are verified); prepayment is not made using funds from a refinancing by the same creditor or its affiliate; the penalty term does not exceed five years from loan consummation; and the penalty is not prohibited under other applicable law. 15 U.S.C. 1639(c); § 226.32(d)(6) and (7). The Board proposes to apply these restrictions to higher-priced mortgage loans. In addition, the Board proposes to require that the period during which a creditor may impose a prepayment penalty expire at least sixty days before the first date, if any, on which the periodic payment amount may increase under the terms of the loan. 60 60 The interagency Statement on Subprime Lending provides that borrowers with certain ARMs should be given a reasonable period of time (typically, at least sixty days) prior to the first rate reset to refinance without penalty. 72 FR 37569, 37574, July 10, 2007. The proposal is intended to prohibit prepayment penalties in cases where they may pose the greatest risk of injury to consumers. The 50 percent DTI cap, while not a perfect measure of affordability, may tend to reduce the likelihood that an unaffordable loan will have a prepayment penalty, which would hinder a consumer's ability to exit the loan by refinancing the loan or selling the house. The same-creditor restriction may reduce the likelihood that a creditor could “pack” a prepayment penalty into a loan as part of a strategy to strip the borrower's equity by flipping the loan in a short time. The five-year restriction would prevent creditors from “trapping” consumers in a loan for an exceedingly long period. The mandatory expiration of the penalty before a possible payment increase would help prevent consumers who had been enticed by a discounted initial payment from being trapped when the payment increased. Thus, the proposal would prohibit prepayment penalties in circumstances indicating a higher risk of injury. The proposal is also intended to preserve the potential benefits of penalties to consumers in cases where the penalties may present less risk to them. Apart from the riskier penalty clauses that would be prohibited, individual consumers would retain a potential option to choose between a penalty clause and a higher interest rate. There are legitimate concerns that consumers are not frequently offered a clear and genuine choice. The Board will be seeking to determine through consumer testing whether it can develop a clear and effective disclosure of a consumer's options. There are also legitimate concerns that, no matter how clearly the choice is disclosed, product complexity and other constraints will tend to undermine individual consumer decision making. See part II.C. In this proposal, however, the Board is weighing against such concerns the potential benefit to all consumers in the subprime market from the increased liquidity that prepayment penalties may provide. Specific Restrictions *Debt-to-income ratio.* TILA and Regulation Z prohibit a prepayment penalty on a HOEPA loan if the borrower's DTI ratio at consummation exceeds 50 percent. 15 U.S.C. 1639(c)(2)(A)(i); § 226.32(d)(7)(iii). The Board proposes to apply this rule to higher-priced mortgage loans. Proposed staff comments would give examples of funds and obligations that creditors commonly classify as “debt” or “income.” Further, the proposal specifies that creditors may, but need not, look to widely accepted governmental and non-governmental underwriting standards to determine how to classify particular funds or obligations as “debt” or “income.” The Board does not propose to require creditors to use any particular standard for calculating debt or income. A creditor would not violate the prepayment penalty rule if its particular calculation method deviated from those in widely-used underwriting handbooks or manuals, so long as the creditor's method was reasonable. The 50 percent DTI cap, while not a perfect measure of affordability, may tend to reduce the likelihood that an unaffordable loan will have a prepayment penalty, which would hinder a consumer's ability to exit the loan by refinancing the loan or selling the house. Loans with high borrower DTI ratios can be affordable, depending on the borrower's circumstances. A borrower whose DTI ratio exceeds 50 percent at consummation, however, will likely have greater difficulty repaying a particular loan, all other things being equal, than a borrower with a lower DTI ratio. TILA Section 129(c)(2)(A)(ii) states that the consumer's income and expenses are to be verified by a financial statement signed by the consumer, by a credit report, and in the case of employment income, by payment records or by verification from the employer of the consumer (which verification may be in the form of a copy of a pay stub or other payment record supplied by the consumer). 15 U.S.C. 1639(c)(2)(A)(ii). The Board's proposal, however, does not permit verification of income, whether from employment by another person or self-employment, by a signed statement of the borrower alone. The proposed rule cross-references proposed § 226.35(b)(2)(i), which requires that income relied upon be verified by reasonably reliable third party documents. There are three bases for the proposal to strengthen the statute's verification requirement. First, under TILA Section 129(l)(2), the Board has a broad authority to update HOEPA's protections as needed to prevent unfair practices. 15 U.S.C. 1639(l)(2)(A). For the reasons discussed in part VII.C., the Board believes that relying on a borrower's statement alone is unfair to consumers, regardless of whether the consumer is employed by another person, self-employed, or unemployed. Second, the Board has a broad authority under Section 129(l)(2) to update HOEPA's protections as needed to prevent their evasion. 15 U.S.C. 1639(l)(2)(A). A signed financial statement declaring all or most of a consumer's income to be self-employment income or income from sources other than employment could be used to evade the statute. Third, adopting a single income verification standard throughout proposed § 226.35(b) would facilitate compliance. *Same creditor.* HOEPA does not permit a prepayment penalty on a HOEPA loan if a prepayment is made with amounts obtained by the consumer through a refinancing with the creditor or an affiliate of the creditor. 15 U.S.C. 1639(c)(2)(B). A prohibition on charging a prepayment penalty in the event of a same-lender refinance discourages originators from seeking to “flip” the loan. To foreclose evasion by creditors who might direct borrowers to refinance with an affiliated creditor, the same-lender refinance rule covers loans by a creditor's affiliate. The Board requests comment on the effect of imposing the same-creditor restriction on a market where loans are frequently sold. *Five-year limit.* HOEPA limits the term of a prepayment penalty on a HOEPA loan to five years after loan origination. 15 U.S.C. 1639(c)(2)(C). The Board believes it would be appropriate to apply the same limitation to prepayment penalties on higher-priced mortgage loans. The Board seeks comment, however, on whether five years is the appropriate limit considering both the need to protect consumers from abuse and the potential benefits of prepayment penalties for consumers. As discussed below, under the proposal a prepayment penalty would have to expire earlier than five years if the payment may increase before then. *Payment increase.* In addition to extending the coverage of HOEPA's prepayment penalty restrictions to a broader segment of the market, the Board proposes to require that, for higher-priced mortgage loans, the period during which a penalty may be imposed expire at least sixty days prior to the first date, if any, on which the periodic payment amount *may* increase. Mandatory expiration of the penalty before a possible payment increase would help prevent consumers who had been enticed by a discounted initial payment from being trapped when the payment increased. The proposed rule would depend on when the rate may increase under the loan agreement, and not on when the rate actually does increase. Although a periodic payment may not actually increase on a rate adjustment date, a creditor may not know whether a borrower's payment will increase in enough time for the creditor to give the borrower a long enough pre-adjustment window in which to refinance without penalty. The proposed bright-line rule would enable creditors and borrowers to know with certainty, at or before loan consummation, the date after which creditors may no longer require a borrower to pay a prepayment penalty. Periodic payments may increase for a variety of reasons, including a scheduled shift from a discounted interest rate to a fully indexed rate, a change in index value on a non-discounted ARM, or mandatory amortization of principal when deferred principal or interest exceeds a certain threshold. For the sake of simplicity, the proposal would set a single standard for all higher-priced mortgage loans for which periodic payments may increase. For example, if a payment-option ARM allows minimum monthly payments for one year and the first adjustment to the monthly payment is scheduled for one year after origination, a prepayment penalty term would have to end at least sixty days before the end of the first year. Furthermore, if monthly payments may change before the first scheduled payment adjustment, a prepayment penalty term would have to end at least sixty days before the first date on which such an unscheduled payment change could occur. For instance, the first adjustment on a loan may be scheduled for three years after loan origination, but the creditor may have the right to make an unscheduled payment change if negative amortization causes the loan's principal amount to exceed a certain threshold. In this case, a prepayment penalty could not be charged fewer than sixty days before the first date on which negative amortization possibly could lead to an increase in the borrower's monthly payments. The mandatory expiration would apply only when *required* payments may increase, not when consumers may opt to pay more than their agreement requires. Moreover, it would not apply to a payment increase due to a borrower's late payment, default, or delinquency. HMDA data for 2004 through 2006 suggest that a sixty-day period before a payment change would be enough time for a significant majority of subprime borrowers to shop for a new loan to refinance the existing obligation. Creditors report price data on first-lien loans if the difference between a loan's APR and the yield on the comparable Treasury security is equal to or greater than 3 percentage points. For 90 percent of the first-lien higher-priced loans, the period between loan application and origination was less than fifty days. For 75 percent of the first-lien higher-priced loans, the period was less than forty-two days. Requests for Comment The Board asks for comment on whether the proposal appropriately balances the potential benefits and potential costs of prepayment penalties to consumers who have higher-priced mortgage loans. The Board asks for specific comment on whether the term allowed for a prepayment penalty should be shorter than five years. Specific comment is also sought on the proposal to strengthen the statute's income verification requirement, and on the potential effects of the same-creditor restriction in a market where creditors sell many of their loans. The Board also requests comment on the proposal to require that a prepayment penalty period on a higher-priced loan expire at least sixty days prior to the first date on which a periodic payment may increase. In particular, the Board asks for comment on the number of days before a possible payment increase that a prepayment penalty should expire. In addition, the Board solicits comments on whether this provision should apply only to loans whose periodic payment may change within a certain number of years (for example, three or five years) after loan consummation. The Board also seeks comment on whether particular loan types (for example, graduated payment, step-rate, or growth equity transactions) should be exempted from a rule on prepayment penalty expiration. Comment on these matters is sought both with respect to the subprime market and any part of the alt-A market the proposal may cover. Comment is also sought both with respect to higher-priced mortgage loans and with respect to the sub-category of HOEPA loans. Notice of Change to Interest Rate and Payment Under Regulation Z § 226.20(c), an adjustment to the interest rate with or without a corresponding adjustment to the payment in a variable-rate transaction requires new disclosures to the consumer. At least 25, but no more than 120, calendar days before a payment at a new level is due, disclosures must be delivered or placed in the mail that state, among other things, the new rate and payment amount, if any. A notice that combined information about a new payment and interest rate with information about the impending expiration of a prepayment penalty period could potentially benefit consumers. Reconciling the current notice with the proposed prepayment penalty period could, however, be difficult. For example, some creditors set a consumer's new payment or rate 30 or 45 days before the first possible change in the monthly payment—after the proposal would require a prepayment penalty period to end. Also, notice of expiration might be more clear and conspicuous to a borrower if provided separately from the § 226.20(c) disclosures. Allowing a combined notice might distort borrower decision making. For example, consumers might mistake a notice of their ability to refinance without penalty as a recommendation that they refinance, though their loan may remain affordable and otherwise favorable compared to available alternatives. An argument can be made that no separate notice of the upcoming expiration of a prepayment penalty period is necessary. Unlike a payment change, the amount of which may remain uncertain until relatively close to the date of any such change, both the creditor and the borrower will have information at loan consummation needed to determine when the prepayment penalty period will expire. On the other hand, consumers may benefit from being reminded when they may prepay without penalty. The Board proposes to defer revising § 226.20(c) or drafting of new disclosure requirements connected with the proposed prepayment penalty period expiration regulation until the Board proposes comprehensive amendments to Regulation Z's closed-end disclosure provisions. Deferral would enable consumer testing of different disclosure options. In the interim, however, consumers might lack adequate information about when they may prepay without penalty. Accordingly, the Board requests comment on whether, if it adopts the proposed prepayment penalty expiration requirement, the Board should specifically address the requirement's interaction with § 226.20(c). E. Requirement to Escrow—§ 226.35(b)(4) The Board proposes to prohibit a creditor from making higher-priced loans secured by a first lien without establishing an escrow account for property taxes and homeowners insurance. Under the proposal, creditors may allow a borrower to “opt out” of the escrow, but not at or before consummation, only twelve months after. The proposed rule would appear in § 226.35(b)(4). Public Comment on Escrows The June 14, 2007 hearing notice solicited comment on the following questions: • Should escrows for taxes and insurance be required for subprime mortgage loans? • If escrows were required, should consumers be permitted to “opt out” of escrows? • Should lenders be required to disclose the absence of escrows to consumers and if so, at what point during a transaction? Should lenders be required to disclose an estimate of the consumer's tax and insurance obligations? • How would escrow requirements affect consumers and the type of and terms of credit offered? Consumer and community groups that commented or testified urged the Board to require escrows on subprime loans. They cited the infrequency of escrows in the subprime market—one group cited a statistic in a servicing trade publication indicating that as few as one-quarter of subprime loans have escrow accounts. Commenters stated that escrows have long been a staple of the prime lending market and suggested that borrowers in the subprime market would benefit as much or more if escrows were available or required. They argued that lack of escrows in the subprime market enables originators to advertise and quote low monthly payments that do not include tax and insurance obligations, misleading borrowers, especially first-time homebuyers. Current homeowners whose monthly payments include contributions to an escrow account may believe that the originator who quotes them a payment without escrow contributions can lower the homeowner's mortgage payment. In reality, the payment on the new loan could be as high, or higher, when property taxes and homeowners insurance are taken into account. Commenters also stated that first-time homebuyers as well as current homeowners with escrow accounts may not be aware of the need to save on their own for tax and insurance payments if they are provided loans without escrows. These borrowers may struggle to meet those obligations when they come due, leaving them vulnerable to loan flipping and equity stripping. Many lenders and financial services trade groups that testified or commented agree that escrowing taxes and insurance is generally beneficial to subprime borrowers as well as lenders, servicers, and investors. Some of these commenters favor a regulation to mandate escrows, assuming it provides them ample time to come into compliance. Some of these commenters, however, would prefer that the Board adopt guidance rather than a regulation to allow flexibility. Other commenters believe that consumers are generally well-enough informed about tax and insurance obligations to save on their own for these payments. These commenters contend that, if escrows were mandated, some potential borrowers would not be able to fund the escrow account at closing. Discussion The Board is concerned that the subprime market does not appear to offer borrowers a genuine opportunity to escrow. Subprime servicers may not set up an escrow infrastructure at all, and subprime originators have disincentives to require or encourage borrowers to take advantage of escrows when they are available. A collective action problem prevails if each individual originator fears that offering escrows would put it at a disadvantage relative to competitors, even if originators collectively would benefit from escrows. 61 Each originator may fear losing business if it escrows. An originator that escrowed would have to quote a monthly payment that included taxes and insurance. Competitors that did not escrow could poach potential or actual customers of the originator by not including taxes and insurance in their quotes. So an originator may be unwilling to escrow without assurance that its competitors also would escrow, though if all originators escrowed then all would likely benefit. 61 An industry representative at the Board's 2007 hearing indicated that her company's internal analysis showed that escrows clearly improved loan performance. Transcript of HOEPA Hearing at 66 (Jun. 14, 2007), available at *http://www.federalreserve.gov/events/publichearings/hoepa/2007/20070614/transcript.pdf.* This market failure causes consumers substantial injury. A lack of escrows in the subprime market may make it more likely that borrowers inadvertently take on mortgages they cannot afford because they focus only on the payment of principal and interest. A lack of escrows may also facilitate misleading payment quotes, which distort competition. Lack of escrows also may make it more likely that borrowers who have trouble saving on their own initiative and would prefer a forced saving plan such as an escrow will not have the resources to pay tax and insurance bills when they come due. This problem may be particularly acute in the subprime market, where borrowers are more likely to be cash-strapped. Failure to pay taxes and insurance is generally an act of default which may subject the property to a public auction or an acquisition by a public agency. Borrowers who face a tax or insurance bill they cannot pay are particularly vulnerable to predatory home equity loans because their situation is urgent. While failure to escrow can cause consumers substantial injury, escrows can also impose costs on consumers. Some borrowers may not be able to afford the cost of funding an escrow at closing. Escrowing also creates an opportunity cost for borrowers who could use the funds for a more productive purpose and still meet their tax and insurance obligations. Some states address this cost at least in part by requiring that an escrow earn interest, but others do not impose such requirements. Moreover, the cost of setting up and administering escrows is passed on at least in part to consumers. The Board has considered these costs in formulating the following proposal. The Board's Proposal The Board is proposing to make escrow accounts mandatory on first-lien higher-priced mortgage loans and permit, but not require, creditors to offer borrowers an option to cancel escrows twelve months after consummation. The Board proposes to define “escrow account” by reference to the definition of “escrow account” in the U.S. Department of Housing and Urban Development's Regulation X (Real Estate Settlement Procedures Act (RESPA)). The Board believes the proposed remedy for the injuries caused by the subprime market's failure to offer escrow accounts appropriately balances the benefits and costs of escrows. Creditors would have an option to allow consumers to limit the opportunity cost of escrow accounts by opting out after one year. The Board is proposing an “opt out” rather than an “opt in” regime because “opt in” would allow some originators to discourage borrowers from escrowing, creating pressure on other originators to follow suit and leaving the collective action problem unresolved. Moreover, an “opt out” available at closing or immediately thereafter would be subject to manipulation. If a consumer could opt out at, or soon after, closing, then some originators might still quote payments without taxes and insurance and tell consumers that they could keep their payments from going up by signing a piece of paper at or shortly after closing. A fairly long period may be required to prevent such circumvention, and to educate borrowers to the benefits of escrowing; the Board proposes twelve months. Requests for Comment The Board seeks comment on whether the benefits of the proposed regulation outweigh the costs. Comment is sought both with respect to the subprime market and with respect to any part of the alt-A market this proposal may cover. The Board also seeks comment on whether creditors should be required, rather than permitted, to allow borrowers to opt out. Comment is also sought on whether a mandatory escrow period different from twelve months would be appropriate, and on whether consumers could effectively be protected from manipulation if the rule permitted them to opt out before closing or soon thereafter. State Escrow Laws The Board recognizes that some state laws limit creditors' ability to require escrows. In addition, certain state laws provide consumers a right to cancel an escrow that the consumer may exercise sooner than twelve months after closing. The Board's proposal would not be consistent with such laws and, if adopted, would preempt them to the extent of the inconsistency. The Board seeks information about which state laws would be inconsistent with this proposal. Other Proposals on Escrows Other parts of this proposal address other issues with escrows. Proposed § 226.35(b)(1) would require creditors to take into account taxes and insurance when determining whether a borrower can repay a loan. Proposed § 226.24(f)(3)(i)(C) would require advertisements that state a payment amount that does not include taxes and insurance to disclose that in close proximity to the payment amount. F. Evasion Through Spurious Open-end Credit—§ 226.35(b)(5) The Board's proposal to exclude HELOCs from the new rules in § 226.35 is discussed in subpart A. above. As noted, the Board recognizes this could lead some creditors to attempt to evade the requirements in § 226.35 by structuring credit as open-end instead of closed-end. Regulation Z § 226.34(b) addresses this risk as to HOEPA coverage by prohibiting structuring a transaction that does not meet the definition of “open-end credit” as a HELOC to evade HOEPA. The Board proposes to extend this approach to new § 226.35. Proposed § 226.35(b)(5) would prohibit a creditor from structuring a closed-end transaction—that is, a transaction that does not meet the definition of “open-end credit”—as a HELOC to evade the limitations in § 226.35. The Board recognizes that consumers may prefer HELOCs to closed-end home equity loans because of the added flexibility HELOCs provide them. It is not the Board's intention to limit consumers' ability to choose between these two ways of structuring home equity credit. An overly broad anti-evasion rule could potentially limit consumer choices by casting doubt on the validity of legitimate open-end plans. The Board seeks comment on the extent to which the proposed anti-evasion rule could have this consequence, and solicits suggestions for a more narrowly tailored rule. For example, the primary concern would appear to be with HELOCs that are substituted for closed-end home purchase loans and refinancings, which are usually first-lien loans, rather than with HELOCs taken for home improvement or other consumer purposes. The Board seeks comment on whether it should limit an anti-evasion rule to HELOCs secured by first liens where the consumer draws down all or most of the entire line of credit immediately after the account is opened. Would such a rule be effective in preventing evasion or would it be easily evaded itself? VIII. Proposed Rules for Mortgage Loans—§ 226.36 Proposed § 226.35, discussed above, would apply certain new protections to higher-priced mortgage loans. In contrast, proposed § 226.36 would apply other new protections to mortgage loans generally, though only if secured by the consumer's principal dwelling. The proposal would prohibit:
(1)Creditors from paying mortgage brokers more than an amount the broker disclosed to the consumer in advance as its total compensation;
(2)creditors or mortgage brokers from coercing or influencing appraisers to misrepresent the value of a dwelling; and
(3)servicers from engaging in unfair fee and billing practices. As with proposed § 226.35, however, proposed § 226.36 would not apply to HELOCs. A. Creditor Payments to Mortgage Brokers—§ 226.36(a) The Board proposes to prohibit a creditor from paying a mortgage broker in connection with a covered transaction unless the payment does not exceed an amount the broker has agreed in advance with the consumer will be the broker's total compensation. The agreement must also disclose that the consumer will pay the entire compensation even if all or part is paid directly by the creditor, and that a creditor's payment to a broker can influence the broker to offer the consumer loan terms or products that are not in the consumer's interest or are not the most favorable the consumer could obtain. Creditors could demonstrate compliance with the provision by obtaining a copy of the broker-consumer agreement and ensuring their payment to the broker does not exceed the amount stated in the agreement. The proposal would provide creditors two alternative means to comply, one where the creditor complies with a state law that provides consumers equivalent protection, a second where a creditor can demonstrate that its payments to a mortgage broker are not determined by reference to the transaction's interest rate. Public Comment on Creditor Payments to Mortgage Brokers Although the Board did not solicit comment on mortgage broker compensation in its notice of the June 2007 hearing, a number of commenters and some panelists raised the topic. In addition, the Board received information about broker compensation from panelists in the 2006 hearings. Consumer and creditor representatives alike have raised concerns about the fairness and transparency of creditor payments to brokers, known as yield spread premiums. Several commenters and panelists stated that consumers are not aware of the payments creditors make to brokers, or that such payments increase consumers' interest rates. They also stated that consumers may mistakenly believe that a broker seeks to obtain the best interest rate available. Consumer groups have expressed particular concern about increased payments to brokers for delivering loans both with higher interest rates and prepayment penalties. Consumer groups suggested, variously, prohibiting creditors paying brokers yield spread premiums, imposing on brokers that accept yield spread premiums a fiduciary duty to consumers, imposing on creditors that pay yield spread premiums liability for broker misconduct, or including yield spread premiums in the points and fees test for HOEPA coverage. Several creditors and creditor trade associations advocated requiring brokers to disclose whether the broker represents the consumer's interests, and how and by whom the broker is to be compensated. Some of these commenters recommended requiring brokers to disclose their total compensation to the consumer and prohibiting creditors from paying brokers more than the disclosed amount. Discussion A yield spread premium is the present dollar value of the difference between the lowest interest rate the wholesale lender would have accepted on a particular transaction and the interest rate the broker actually obtained for the lender. This dollar amount is usually paid to the mortgage broker, though it may also be applied to other closing costs. (This proposal would restrict only amounts paid to and retained by the broker, however, and not amounts the broker is obligated to pass on to other settlement service providers.) The creditor's payment to the broker based on the interest rate is an alternative to the consumer's paying the broker directly from the consumer's preexisting resources or from the loan proceeds. Preexisting resources or loan proceeds may not be sufficient to cover the broker's total fee, or may appear to the consumer to be a more costly way to finance those costs if the consumer expects to prepay the loan in a relatively short period. Thus, consumers potentially benefit from having an option to pay brokers for their services indirectly by accepting a higher interest rate. The Board shares concerns, however, that creditor payments to mortgage brokers are not transparent to consumers and are potentially unfair to them. Creditor payments to brokers based on the interest rate give brokers an incentive to provide consumers loans with higher interest rates. Some brokers may refrain from acting on this incentive out of legal, business, or ethical considerations. Moreover, competition in the mortgage loan market may often limit brokers' ability to act on the incentive. The market often leaves brokers room to act on the incentive should they choose, however, especially as to consumers who are less sophisticated and less likely to shop among either loans or brokers. Large numbers of consumers are simply not aware the incentive exists. Many consumers do not know that creditors pay brokers based on the interest rate, and current legally required disclosures seem to have only limited effect. 62 Some consumers may not even know that creditors pay brokers: a common broker practice of charging a small part of its compensation directly to the consumer, to be paid from the consumer's existing resources or loan proceeds, may lead consumers to believe, incorrectly, that this amount is all the consumer will pay or the broker will receive. Consumers who do understand that the creditor pays the broker based on the interest rate may not fully understand the implications of the practice. They may not appreciate the full extent of the incentive this gives the broker to increase the rate because they do not know the dollar amount of the creditor's payment. 62 This is true not only of state-mandated disclosures but also of the early federal disclosure currently in place under the Real Estate Settlement Procedures Act (RESPA), the good faith estimate of settlement costs (GFE). As the Department of Housing and Urban Development
(HUD)has noted, the current GFE does not convey to consumers an adequate understanding of how mortgage brokers are paid. RESPA Simplification, 67 FR 49134, 49140-41, Jul. 29, 2002 (proposed rule under RESPA). Moreover, consumers often wrongly believe that brokers agree, or are required, to obtain the best interest rate available. Several commenters in connection with the 2006 hearings suggested that mortgage broker marketing cultivates an image of the broker as a “trusted advisor” to the consumer. Consumers who have this perception may rely heavily on a broker's advice, and there is some evidence that such reliance is common. In a 2003 survey of older borrowers who had obtained prime or subprime refinancings, seventy percent of respondents with broker-originated refinance loans reported that they had relied “a lot” on their brokers to find the best mortgage for them. 63 63 Kellie K. Kim-Sung & Sharon Hermanson, *Experiences of Older Refinance Mortgage Loan Borrowers: Broker- and Lender-Originated Loans,* Data Digest No. 83 (AARP Public Policy Inst., Washington, D.C.), Jan. 2003, at 3, available at *http://www.aarp.org/research/credit-debt/mortgages/experiences_of_older_refinance_mortgage_loan_borro.html* . If consumers believe that brokers protect consumers' interests by shopping for the lowest rates available, then consumers will be less likely to take steps to protect their own interests when dealing with a broker. For example, they may be less likely to shop rates across retail and wholesale channels simultaneously to assure themselves the broker is providing a competitive rate. They may also be less likely to shop and negotiate brokers' services, obligations, or compensation up-front, or at all. For example, they may be less likely to seek out brokers who will promise in writing to obtain the lowest rate available. The Board's Proposal The Board proposes to prohibit a creditor from paying a mortgage broker in connection with a covered transaction unless the payment does not exceed an amount the broker has agreed with the consumer in advance will be the broker's total compensation. The proposal would restrict only amounts the broker retains, not amounts the broker distributes to other settlement service providers. The agreement must also disclose that the consumer will pay the entire compensation even if all or part is paid directly by the creditor, and that a creditor's payment to a broker can influence the broker to offer the consumer loan terms or products that are not in the consumer's interest or are not the most favorable the consumer could obtain. The commentary would provide model language for each of these disclosures, which the Board anticipates testing with consumers. The broker and consumer must have entered into the agreement before the consumer had paid a fee to any person or submitted a written application to the broker, whichever occurred earlier. The proposal is intended to limit the potential for unfairness, deception, and abuse in creditor payments to brokers in exchange for higher interest rates while preserving this option for consumers to finance their obligations to brokers. Conditioning such payments on a broker's advance commitment to the consumer to limit its compensation to a specified dollar amount may increase transparency and improve competition in the market for brokerage services. Improved competition could lower the price of brokerage services, improve the quality of those services, or both. When consumers are aware how much they will pay for a broker's services, they may be more likely to shop and negotiate among brokers based on broker fees, broker services, and other terms of broker contracts. Disclosing that the consumer ultimately pays the broker's compensation would help ensure that the disclosure of a compensation figure was meaningful and not undermined by a consumer's perception that the creditor, not the consumer, shoulders the broker fee. Disclosing that the creditor's payment may influence the broker not to serve the best interests of the consumer would help ensure that consumers were on notice of the need to protect their own interests when dealing with a mortgage broker rather than assume that the broker would fully protect their interests. The rule is intended to impose a fairly minimal compliance burden. A creditor would demonstrate compliance by obtaining a copy of a timely executed broker-consumer agreement and ensuring that it did not pay the broker more than the amount stated in the agreement, reduced by any amount paid directly by the consumer. The amount paid directly by the consumer, if any, would appear on the HUD-1 Settlement Statement prepared in accordance with the Real Estate Settlement Procedures Act. The Board considered imposing a disclosure obligation directly on brokers. It does not appear, however, that a disclosure alone would provide consumers adequate protection. More protection is provided where creditors are prohibited from paying more than the amount disclosed. *Compensation amount.* The proposal would require that the compensation be disclosed as a flat dollar amount. The proposal would not permit disclosing a range of fees or a percentage figure. The Board recognizes that disclosure in these or other forms has been common. The Board is concerned, however, that disclosure in a form other than a flat dollar amount, however, would not be meaningful to consumers. *Timing.* The proposal would require that the broker-consumer agreement have been entered into before the consumer pays a fee to any person in connection with the transaction or submits an application. This is intended to ensure the consumer has not already become “locked in” to a relationship with the broker by paying a fee or submitting an application. The early timing requirement may also tend to limit the risk that a broker would price discriminate on the basis of the sophistication and market options of the borrower. The Board recognizes that requiring a broker who seeks to be paid by the creditor to commit to its fee this early in its relationship with the consumer may lead brokers to price their services on the basis of the average cost of a transaction rather than separately for each transaction. Average cost pricing can potentially create some inefficiency. The Board believes, however, that this cost may be outweighed by the increased efficiency from improved transparency. *Loans covered.* The proposed rule would apply to the prime market as well as the subprime market. The Board recognizes that injury to consumers in the prime market is likely more limited than injury in the subprime market because loans in the prime market have a much narrower range of interest rates, which limits the rents that can be extracted from consumers. The Board is concerned, however, that the lack of transparency discussed above may injure borrowers in the prime market, too, even if not to the same degree. *Originators covered.* The proposal is limited to creditor payments to brokers. A broker would be defined as a person, other than a creditor's employee, who for monetary gain arranges, negotiates, or otherwise obtains an extension of credit for a consumer. See proposed § 226.36(c). A person who met this definition would be considered a mortgage broker even if the credit obligation was initially payable to the person, unless the person funded the transaction from its own resources, from deposits, or from a bona fide warehouse line of credit. The Board is aware of concerns that a rule restricting, and encouraging disclosure of, lender payments to brokers but not lender payments to their employees could create an “uneven playing field” between brokers and lenders. Creditors sometimes pay their employed loan officers on a basis similar to their payment of yield spread premiums to independent brokers. To the extent a loan originated through an employee exceeds the creditor's “par” rate, the creditor may realize a gain from selling the loan on the secondary market and it may share some of this gain with the employee. Such payments give employees an incentive to increase the interest rate. The Board does not propose, however, to restrict creditor payments to their own employees. The Board is not aware of significant evidence that consumers perceive lenders' employees the way they often perceive independent brokers—as trusted advisors who shop for the best loan for a consumer among a wide variety of sources. Accordingly, it is not clear that a key premise of the proposal to restrict creditor payments to brokers—that consumers expect a broker has a legal or professional obligation to give disinterested advice and find the consumer the best loan available—holds true for creditor payments to their own employees. In addition, extending the proposal to creditor payments to their employees could present difficult practical problems. For example, a creditor may not know even as of consummation whether it will sell a particular loan in the secondary market. If the creditor is nonetheless certain to sell the loan, it may not know until near or at consummation what its gain will be or, therefore, how much it will pay its employee. *Compliance alternatives.* The proposal would provide creditors two alternative ways to comply, one where the creditor complies with a state law that provides consumers equivalent protection, a second where a creditor can demonstrate that its payments to a mortgage broker are not determined by reference to the transaction's interest rate. The first safe harbor is for a creditor payment to a broker for a transaction in connection with a state statute or regulation that
(a)expressly prohibits the broker from being compensated in a manner that would influence a broker to offer loan products or terms not in the consumer's interest or not the most favorable the consumer could obtain; and
(b)requires that a mortgage broker provide consumers with a written agreement that includes a description of the mortgage broker's role in the transaction and the broker's relationship to the consumer, as defined by such statute or regulation. An example would be a state statute or regulation that imposed a fiduciary obligation on a mortgage broker not to puts its own interests ahead of the consumer's and required the broker to disclose this obligation in an agreement with the consumer. The second alternative is for a creditor that can demonstrate that the compensation it pays to a mortgage broker in connection with a transaction is not determined, in whole or in part, by reference to the transaction's interest rate. For instance, if a creditor can show that it pays brokers the same flat fee for all transactions regardless of the interest rate, the creditor would not be subject to the restriction on payments to brokers under § 226.36(a)(1). Requests for Comment The Board seeks comment generally on the costs and benefits of the proposal, including the proposed alternatives means of compliance. The Board seeks specific comment on whether it would be appropriate to apply the proposed rule, or a similar rule, to lender payments to loan originators in their employ and, if so, how the rule would address practical difficulties such as those discussed above. Further, the Board seeks comment on whether the benefits of applying the proposed rule to the prime market would outweigh the costs, including potential unintended consequences. The Board seeks specific comment on whether the proposed rule should be limited to higher-priced mortgage loans as defined in proposed § 226.35(a). The Board also seeks comment on the proposed condition that the broker-consumer agreement have been entered into before the consumer pays a fee to any person in connection with the transaction or submits an application. Would brokers have a reduced incentive to shop actively among potential sources of financing for the lowest possible rate? Would a broker potentially terminate its relationship with a consumer without obtaining a loan for the consumer because the consumer's particular needs would be more difficult to meet than the broker anticipated when it set its compensation? If these are concerns, would it be appropriate for the Board to provide a narrow allowance for renegotiation of the broker's compensation later in the application process? How should such a permission be crafted to ensure transparency and protect consumers from unfair practices such as “bait and switch”? The Proposed Rule's Relationship to Other Laws The Board recognizes that HUD has issued policy statements regarding creditor payments to mortgage brokers under RESPA and guidance as to disclosure of such payments on the Good Faith Estimate and HUD-1 Settlement Statement. The Board is also aware that HUD has announced its intention to propose improved disclosures for broker compensation under RESPA in the near future. The Board intends that its proposal would complement any proposal by HUD and operate in combination with that proposal to meet the agencies' shared objectives of fair and transparent markets for mortgage loans and for mortgage brokerage services. The Board and HUD have discussed their mutual desire and intention to work together to achieve these objectives while minimizing any duplication between their regulations. Accordingly, the proposed restriction of creditor payments to mortgage brokers is intended to be consistent with HUD's existing guidance regarding creditor compensation to brokers under Section 8 of RESPA, 12 U.S.C. 2607. The Board is also aware that many states regulate brokers and their compensation in various respects. Under TILA Section 111, the proposed rule would not preempt such state laws except to the extent they are inconsistent with the proposal's requirements. 15 U.S.C. 1610. The Board seeks comment on the relationship of this proposal to state laws. B. Coercion of Appraisers—§ 226.36(b) The Board proposes to prohibit creditors and mortgage brokers from coercing appraisers to misrepresent the value of a consumer's principal dwelling. The Board also proposes to prohibit creditors from extending credit when creditors know or have reason to know, at or before loan consummation, that an appraiser has misstated a dwelling's value. The regulation would apply to all consumer credit transactions secured by a consumer's principal dwelling. Discussion Some responses to the Board's request for public comment urged the Board to address coercion of appraisers, even though the Board did not specifically request comment on that issue. For example, the National Association of Attorneys General and many consumer and community groups cited inflated appraisals as a problem in the home mortgage market. A lender trade association suggested that the Board require appraisers to report instances of improper pressure and ban inflation of appraisals. Appraiser trade associations and several consumer and community groups urged the Board to prohibit coercion of appraisers as an unfair or deceptive act or practice. Also, testimony before Congress has cited data that suggests that appraisers frequently are subject to coercion. 64 64 For example, on June 26, 2007, at a hearing of the U.S. Senate Committee on Banking, the President of the Appraisal Institute testified for several appraiser trade organizations about threats to appraiser independence. He cited a 2007 survey by the October Research Corporation that found that 90 percent of appraisers reported having been pressured to report higher property values, a percentage almost twice as high as reported in a 2003 survey. *Ending Mortgage Abuse: Safeguarding Homebuyers: Hearing before the Subcomm. on Hous., Transp., & Comm'y Dev. of the S. Comm. on Banking, Hous., and Urban Affairs* 4, 110th Cong.
(2007)(statement of Alan Hummel, Chair, Government Relations Committee, Appraisal Institute). Pressuring an appraiser to overstate, or understate, the value of a consumer's dwelling distorts the lending process and harms consumers. If the appraisal is inflated on a home purchase loan, a consumer may pay more for the house than the consumer otherwise would have. Inflated appraisals also may lead consumers to think they have more equity in their homes than they really have, and consumers may borrow or make other financial decisions based on this incorrect information. For example, a consumer who purchases a home based on an inflated appraisal may overestimate her ability to refinance and may take on a riskier loan than she otherwise would have. Moreover, the consumer would not necessarily be aware that an appraisal had been inflated or appreciate the risk that appraisal inflation entailed. Understated appraisals, though perhaps less common, can cause consumers to be denied access to credit for which they were qualified. Inflated appraisals of homes concentrated in a neighborhood may affect other appraisals, since appraisers factor the value of comparable properties into their property valuation. For the same reason, understated appraisals may affect appraisals of neighboring properties. Thus, inflated or understated appraisals can harm consumers other than those who are party to the transaction with the inflated appraisal. Moreover, these consumers are not in a position to know of the practice or avoid it. State legislatures and enforcement agencies have addressed concerns about parties who exert undue influence over appraisers' property valuations. 65 Several states have banned coercion of appraisers or enacted general laws against mortgage fraud that may be used to combat appraiser coercion. 66 In 2006, forty-nine states and the District of Columbia (collectively, the Settling States) entered into a settlement agreement with ACC Capital Holdings Corporation and several of its subsidiaries, including Ameriquest Mortgage Company (collectively, the Ameriquest Parties). The Settling States alleged that the Ameriquest Parties had engaged in deceptive or misleading acts that resulted in the Ameriquest Parties' obtaining inflated appraisals of homes' value. 67 To settle the complaints, the Ameriquest Parties agreed to abide by policies designed to ensure appraiser independence and accurate valuations. Also, the Attorneys General of New York and Ohio recently have filed actions that allege, among other violations, the exertion of improper influence over appraisers. 65 The federal financial institution regulatory agencies have issued regulations to the institutions they supervise that explain, among other things, how those institutions should promote appraiser independence. The Board's proposal is not intended to alter those regulations or any other federal or state statutes, regulations, or agency guidance related to appraisals. 66 *See, e.g.* , Colo. Rev. Stat. § 6-1-717; Iowa Code § 543D.18A; Ohio Rev. Code Ann. §§ 1322.07(G), 1345.031(B)(10), 4763.12(E). 67 *See,* *e.g., Iowa ex rel. Miller* v. *Ameriquest Mortgage Co.,* No. 05771 EQCE-053090 (Iowa D. Ct. 2006) (Pls. Pet. 5). The Board's Proposal To address the harm from improper influencing of appraisers, the Board proposes to prohibit creditors and mortgage brokers and their affiliates from pressuring an appraiser to misrepresent a dwelling's value, for all closed-end consumer credit transactions secured by a consumer's principal dwelling. The proposed regulation defines the term “appraiser” as a person who engages in the business of providing, or offering to provide, assessments of the value of dwellings. Further, the Board's proposed regulation prohibits a creditor from extending credit if the creditor knew or had reason to know that a broker had coerced an appraiser to misstate a dwelling's value, unless the creditor acted with reasonable diligence to determine that the appraisal was accurate. For example, an appraiser might notify a creditor that a mortgage broker had tried—and failed—to get the appraiser to inflate a dwelling's value. If, after reasonable, documented investigation, the creditor found that the appraiser had not misstated the dwelling's value, the creditor could extend credit based on the appraiser's valuation. The proposed commentary states that, alternatively, the creditor could extend credit based on another appraisal untainted by improper influence. The commentary to the proposed regulation gives examples of acts that would violate the regulation: implying to an appraiser that retention of the appraiser depends on the amount at which the appraiser values a consumer's principal dwelling; failing to compensate an appraiser or to retain the appraiser in the future because the appraiser does not value a consumer's principal dwelling at or above a certain amount; and conditioning an appraiser's compensation on loan consummation. The commentary also lists examples of acts that would not violate the regulation: requesting that an appraiser consider additional information for, provide additional information about, or correct factual errors in a valuation; obtaining multiple appraisals of a dwelling (provided that the creditor or mortgage broker selects appraisals based on reliability rather than on the value stated); withholding compensation from an appraiser for breach of contract or substandard performance of services or terminating a relationship for violation of legal or ethical standards; and taking action permitted or required by applicable federal or state statute, regulation, or agency guidance. A regulation under HOEPA that expressly prohibits creditors and brokers from pressuring appraisers to misstate or misrepresent the value of a consumer's dwelling would provide enforcement agencies in every state with a specific legal basis for an action alleging appraiser coercion. The Board requests comments on the potential costs and benefits of its proposed appraiser influence regulation. The Board seeks specific comment on the appropriateness of proposed examples of actions that would or would not violate the proposed regulation. C. Servicing Abuses—§ 226.36(d) The Board proposes to prohibit certain practices on the part of servicers of closed-end consumer credit transactions secured by a consumer's principal dwelling. Proposed § 226.36(d) would provide that no servicer shall:
(1)Fail to credit a consumer's periodic payment as of the date received;
(2)impose a late fee or delinquency charge where the only late fee or delinquency charge is due to a consumer's failure to include in a current payment a delinquency charge imposed on earlier payments;
(3)fail to provide a current schedule of servicing fees and charges within a reasonable time of request; or
(4)fail to provide an accurate payoff statement within a reasonable time of request. Discussion Although the Board did not solicit comment on whether certain mortgage servicer practices should be prohibited or restricted in its notices of the 2006 or 2007 hearings, some commenters raised the topic in that context. The issue has also been presented in recent congressional testimony. Consumer advocates have raised concerns that some servicers may be charging consumers unwarranted or excessive fees, such as late fees and other “service” fees, in the normal course of mortgage servicing, as well as in foreclosure scenarios. There is anecdotal evidence that significant numbers of consumers have complained about servicing practices, and instances of unfair practices have been cited in court cases. 68 In 2003, the FTC announced a $40 million settlement with a large mortgage servicer and its affiliates to address allegations of abusive behavior. 69 Consumer advocates have also raised concerns that consumers are sometimes unable to understand the basis upon which fees are charged, in part because disclosure and other forms of notice to consumers of servicer fees are limited. 68 *See, e.g., Islam* v. *Option One Mortgage Corp.,* 432 F. Supp. 2d 181 (D. Mass 2006); *In Re Coates,* 292 B.R. 894 (D. Ill. 2003); *In Re Gorshstein,* 285 B.R. 118 (S.D.N.Y. 2002); *In re Tate,* 253 B.R. 653 (2000); *Rawlings* v. *Dovenmuehle Mortgage Inc.,* 64 F. Supp. 2d 1156 (M.D. Ala. 1999); *Ronemus* v. *FTB Mortgage Servs.,* 201 B.R. 458 (1996). 69 Consent Order, *United States* v. *Fairbanks Capital Corp.,* Civ. No. 03-12219-DPW (D. Mass Nov. 21, 2003, as modified Sept. 4, 2007). *See also Ocwen Federal Bank FSB,* Supervisory Agreement, OTS Docket No. 04592 (Apr. 19, 2004) (settlement resolving mortgage servicing issues). The Board shares concerns about abusive servicing practices. Before securitization became commonplace, a lending institution would often act as both originator and collector—that is, it would service its own loans. Today, however, separate servicing companies play a key role: they are chiefly responsible for account maintenance activities, including collecting payments (and remitting amounts due to investors), handling interest rate adjustments, and managing delinquencies or foreclosures. Servicers also act as the primary point of contact for consumers. In exchange for performing these services, servicers generally receive a fixed per-loan or monthly fee, float income, and ancillary fees—including default charges—that the consumer must pay. A potential consequence of the “originate-to-distribute” model discussed in part II.C. above is the misalignment of incentives between consumers, servicers, and investors. Servicers contract directly with investors, and consumers are not a party to the contract. The investor is principally concerned with maximizing returns on the mortgage loans. So long as returns are maximized, the investor may be indifferent to the fees the servicer charges the borrower. Consumers do not have the ability to shop for servicers and have no ability to change servicers (without refinancing). As a result, servicers do not compete in any direct sense for consumers. Thus, there may not be sufficient market pressure on servicers to ensure competitive practices. As a result, as described above, substantial anecdotal evidence of servicer abuse exists. For example, servicers may not timely credit, or may misapply, payments, resulting in improper late fees. Even where the first late fee is properly assessed, servicers may apply future payments to the late fee first, making it appear future payments are delinquent even though they are, in fact, paid in full within the required time period, and permitting the servicer to charge additional late fees—a practice commonly referred to as “pyramiding” of late fees. The Board is also concerned about the transparency of servicer fees and charges, especially because consumers may have no notices of such charges prior to their assessment. Consumers may be faced with charges that are confusing, excessive, or cannot easily be linked to a particular service. In addition, servicers may fail to provide payoff statements in a timely fashion, thus impeding consumers from refinancing existing loans. The Board's Proposal The Board is proposing to restrict certain servicing practices and to provide more transparency in the servicing market. Proposed § 226.36(d) would prohibit four servicing practices that are likely to harm consumers. First, the proposal would prohibit a servicer from failing to credit a payment to a consumer's account as of the same date it is received. Second, the proposal would prohibit “pyramiding” of late fees, by prohibiting a servicer from imposing a late fee on a consumer for making an otherwise timely payment that would be the full amount currently due but for its failure to include a previously assessed late fee. Third, the proposal would prohibit a servicer from failing to provide to a consumer, within a reasonable time after receiving a request, a schedule of all specific fees and charges it imposes in connection with mortgage loans it services, including the dollar amount and an explanation of each fee and the circumstances under which it will be imposed. Fourth, the proposal would prohibit a servicer from failing to provide, within a reasonable time after receiving a request, an accurate statement of the amount currently required to pay the obligation it services in full, often referred to as a payoff statement. Under proposed § 226.36(d)(3), the term “servicer” and “servicing” are given the same meanings as provided in Regulation X, 24 CFR 3500.2. As described in part V above, TILA Section 129(l)(2) authorizes protections against unfair practices by non-creditors and against unfair or deceptive practices outside of the origination process, when such practices are “in connection with mortgage loans.” 15 U.S.C. 1639(l)(2). The Board believes that unfair or deceptive servicing practices fall squarely within the purview of Section 129(l)(2) because servicing is an integral part of the life of a mortgage loan and, therefore, has a close and direct “connection with mortgage loans.” Accordingly, the Board bases its proposal to prohibit certain unfair or deceptive servicing practices on its authority under Section 129(l)(2), 15 U.S.C. 1639(l)(2). Late Payments The proposed rule prohibiting the failure to credit payments as of the date received would be substantially similar to the existing provision requiring prompt crediting of payment on open-end transactions in § 226.10. Accordingly, proposed § 226.36(d)(1)(i) would require a servicer to credit a payment to the consumer's loan account as of the date of receipt, except when a delay in crediting does not result in a finance or other charge or in the reporting of negative information to a consumer reporting agency except as provided in § 226.36(d)(2). As the proposed commentary would make clear, the proposal would not require that a servicer physically enter the payment on the date received, but would require only that it be credited *as of* the date received. Thus, a servicer that receives a payment on or before its due date and does not enter the payment on its books until after the due date does not violate the requirement as long as the entry does not result in the imposition of a late charge, interest, or other charge to the consumer. The Board seeks comment on whether (and if so, how) partial payments should be addressed in this provision. Similar to § 226.10(b), proposed § 226.36(d)(2) would require a servicer that specifies payment requirements in writing, but that accepts a non-conforming payment, to credit the payment within five days of receipt. The proposed commentary is also similar to the commentary accompanying § 226.10(b); for example, it explains that the servicer may specify in writing reasonable requirements for making payments, such as setting a cut-off hour for payment to be received. The Board seeks comment on whether the commentary should include a safe harbor as to what constitutes a reasonable payment requirement, for example, a cut-off time of 5 p.m. for receipt of a mailed check. Pyramiding Late Fees The prohibition on pyramiding late fees parallels the existing prohibition in the “credit practices rule,” under section 5 of the FTC Act, 15 U.S.C. 45. *See,* *e.g.* , 12 CFR 227.15 (Board's Regulation AA). Proposed § 226.36(d)(1)(ii) would prohibit servicers from imposing any late fee or delinquency charge on the consumer in connection with a payment, when the only delinquency is attributable to late fees or delinquency charges assessed on an earlier payment, and the payment is otherwise a full payment for the applicable period and is paid on its due date or within an applicable grace period. The proposed commentary provides that the prohibition should be construed consistently with the credit practices rule. Servicers are currently subject to this rule, whether they are banks (Regulation AA), thrifts (12 CFR 535.4), or other kinds of institutions (16 CFR 444.4). Consumers may nevertheless benefit if the Board adopted the same requirement under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). This would permit state attorneys general to enforce the rule uniformly, where currently they may be limited to enforcing the rule through state statutes that may vary. Accordingly, violations of the anti-pyramiding rule by servicers would provide state attorneys general an additional means of enforcement. Schedule of Fees and Charges The third proposed rule would require a servicer to provide to a consumer upon request a schedule of all specific fees and charges that may be imposed in connection with the servicing of the consumer's account, including a dollar amount and an explanation of each and the circumstances under which it may be imposed. The Board believes that making the fee schedule available to consumers upon request will bring transparency to the market and will make it more difficult for unscrupulous servicers to camouflage or inflate fees. Therefore, the proposal would require the servicer to provide, upon request, a fee schedule that is specific both as to the amount and reason for each charge, to prevent servicers from disguising fees by lumping them together or giving them generic names. The proposed commentary would also explain that a dollar amount may be expressed as a flat fee or, if a flat fee is not feasible, as an hourly rate or percentage. Thus, if the services of a foreclosure attorney are required, the servicer might list the attorney's hourly rate because it would be difficult for a servicer to determine a flat dollar amount. However, it might not be difficult for a servicer to determine a flat delivery service fee. The Board believes that disclosure of a dollar figure for each fee will discourage abusive servicing practices by enhancing the consumer's understanding of servicing charges. The Board seeks comment on the effectiveness of this approach, and on any alternative methods to achieve the same objective. Further, the proposed commentary would clarify that “fees imposed” by the servicer include third party fees or charges passed on by the servicer to the consumer. The Board recognizes that servicers may have difficulty identifying third party charges with complete certainty, because third party fees may vary depending on the circumstances (for example, fees may vary by geography). The Board seeks comment on whether the benefit of increasing the transparency of third party charges would outweigh the costs associated with a servicer's uncertainty as to such charges. The proposed commentary would clarify that a servicer who receives a request for the schedule of fees may either mail the schedule to the consumer or direct the consumer to a specific Web site where the schedule is located. The Board believes that having the option to post the schedule on a Web site will greatly reduce the burden on servicers to provide schedules. However, the proposed commentary provides that any such Web site address reference must be specific enough to inform the consumer where the schedule is located, rather than solely referring to the servicer's home page. Loan Payoff Statement Proposed § 226.36(d)(1)(iv) would prohibit a servicer from failing to provide, within a reasonable time after receiving a request from the consumer or any person acting on behalf of the consumer, an accurate statement of the full amount required to pay the obligation in full as of a specified date, often referred to as a payoff statement. Servicers' delay in providing payoff statements has impeded consumers from refinancing existing loans or otherwise clearing title. Such delays increase transaction costs and may discourage consumers from pursuing a refinance opportunity. The proposed commentary states that under normal market conditions, three business days would be a reasonable time to provide the payoff statements; however, the commentary states that a reasonable time might be longer than three business days when servicers are experiencing an unusually high volume of refinancing requests. Under this provision, the servicer would be required to respond to the request of a person acting on behalf of the consumer; this is to ensure that the creditor with whom the consumer is refinancing receives the payoff statement in a timely manner. It also ensures that others who act on the consumer's behalf, such as a non-profit homeownership counselor, can obtain a payoff statement for the consumer within a reasonable time. D. Coverage—§ 226.36(e) Proposed § 226.36 would apply new protections to mortgage loans generally, if primarily for a consumer purpose and secured by the consumer's principal dwelling, because the Board believes that the concerns addressed by proposed § 226.36 also apply to the prime market. However, the Board proposes to exclude HELOCs from coverage of § 226.36 because the risks to consumers addressed by the proposal may be lower in connection with HELOCs than with closed-end transactions. Most originators of HELOCs hold them in portfolio rather than sell them, which aligns these originators' interests in loan performance more closely with their borrowers' interests. Further, consumers with HELOCs can be protected in other ways besides regulation under HOEPA. Unlike closed-end transactions, HELOCs are concentrated in the banking and thrift industries, where the federal banking agencies can use their supervisory authority to protect consumers. 70 Similarly, TILA and Regulation Z already contain a prompt crediting rule for HELOCs, 12 CFR 226.10, of the kind the Board is proposing in § 226.36(d). 70 *See, e.g.* , Interagency Credit Risk Management Guidance for Home Equity Lending, Fed. Reserve Bd. SR Letter 05-11 (May 16, 2005); Addendum to Credit Risk Management Guidance for Home Equity Lending, Fed. Reserve Bd. SR Letter 06-15 app. 3 (Nov. 26, 2006). The Board seeks comment on whether there is a need to apply any or all of the proposed prohibitions in § 226.36 to HELOCs. For example, one source reports that the proportion of HELOCs originated through mortgage brokers is quite small. 71 This may suggest that the risks of improper creditor payments to brokers or broker coercion of appraisers in connection with HELOCs is limited. Are mortgage brokers growing as a channel for HELOC origination such that regulation under §§ 226.36(a) through 226.36(c) is necessary? Do originators contract out HELOC servicing often enough to necessitate the proposed protections of § 226.36(d)? If coverage should be extended to HELOCs, the Board also solicits comment as to whether such coverage should be limited to specific types of HELOCs. For example, do purchase money HELOCs, which are often used in combination with first-lien closed-end loans to purchase a home, mirror the risks associated with first-lien loans? 71 Consumer Bankers Ass'n, *2006 Home Equity Loan Study* (June 30, 2006) (reporting that about 10 percent of HELOCs were originated through a broker channel recently). IX. Other Potential Concerns A. Other HOEPA Prohibitions As discussed in part VII, the Board is proposing to extend to higher-priced mortgage loans two of the restrictions HOEPA currently applies only to HOEPA loans, concerning determinations of repayment ability and prepayment penalties. *See* TILA Section 129(c) and (h), 15 U.S.C. 1639(c) and (h). HOEPA also prohibits negative amortization, interest rate increases after default, balloon payments on loans with a term of less than five years, and prepaid payments. TILA Section 129(d)-(g), 15 U.S.C. 1639(d)-(g). In addition, the statute prohibits creditors from paying home improvement contractors directly unless the consumer consents in writing. TILA Section 129(j), 15 U.S.C. 1639(j). In 2002, the Board added to these limitations on HOEPA loans a regulatory prohibition on due-on-demand clauses and on refinancings by the same creditor (or assignee) within one year unless the refinancing is in the borrower's interest. 12 CFR 226.32(d)(8) and 226.34(a)(3). The Board seeks comment on whether any of these restrictions should be applied to higher-priced mortgage loans. Is there evidence that any of these practices has caused consumers in the subprime market substantial injury or has the potential to do so? Would the benefits of applying the restriction to higher-priced mortgage loans outweigh the costs, considering both the subprime market and the part of the alt-A market that may be covered by the proposal? Negative amortization has been a particular concern in recent years because of the rapid spread of nontraditional mortgages that permit consumers to defer for a time paying any principal and to pay less than the interest due. What are the costs and benefits for consumers of negative amortization in the part of the market that would be covered under the definition of higher-priced mortgage loans? Would proposed § 226.35(b)(1), which would generally prohibit a pattern or practice of extending higher-priced mortgage loans without regard to consumers' repayment ability—taking into account a fully-amortizing payment—adequately address concerns about negative amortization on such loans? Historically, loans with balloon payments also have been of concern in the subprime market. What are the costs and benefits for consumers of balloon loans in the part of the market that would be covered under the definition of higher-priced mortgage loans? Should the Board prohibit balloon payments with such loans and, if so, should balloon payments be permitted on loans with terms of more than five years, as HOEPA now permits? Proposed § 226.35(b)(1) would provide creditors a safe harbor from the prohibition against a pattern or practice of lending without regard to repayment ability if the creditor has a reasonable basis to believe consumers will be able to make loan payments for at least seven years after consummation of the transaction. Would this safe harbor tend to encourage creditors to restrict balloon payments to the eighth year, or later? If so, would the proposal provide consumers adequate protections from balloon loans without a regulation specifically addressing them? B. Steering Consumer advocates and others have expressed concern that borrowers are sometimes steered into loans with prices higher than the borrowers' risk profiles warrant or terms and features not suitable to the borrower. Existing law also restricts steering. If a creditor steered borrowers to higher-rate loans or to certain loan products on the basis of borrowers' race, ethnicity, or other prohibited factors, the creditor would violate the Equal Credit Opportunity Act, 15 U.S.C. 1601 *et seq.* , and Regulation B, 12 CFR 202, as well as the Fair Housing Act, 42 U.S.C. 3601 *et seq.* Moreover, two parts of this proposal would help to address steering regardless whether the steering had a racial basis or other prohibited basis. First, proposed § 226.36(a) would limit creditor payments to mortgage brokers to an amount the broker had agreed with the consumer in advance—before the broker could know what rate the consumer would qualify for—would be the broker's total compensation. This provision also would prohibit the payment unless the broker had given the consumer a written notice that a broker that receives payments from a creditor may have incentives not to provide the consumer the best or most suitable rates or terms. These restrictions are intended to reduce the incentive and ability of a mortgage broker to offer a consumer a higher rate simply so that the broker, without the consumer's knowledge, could receive a larger payment from the creditor. Second, proposed § 226.35(b)(1) would prohibit a creditor from engaging in a pattern or practice of extending higher-priced mortgage loans based on the collateral without regard to repayment ability. Thus, if a creditor steered borrowers into higher-priced mortgage loans that the borrower may not have the ability to repay—or accepted loans from brokers that had done so—the creditor would risk violating proposed § 226.35(b)(1). X. Advertising The Board proposes to amend the advertising rules for open-end home-equity plans under § 226.16, and for closed-end credit under § 226.24 to address advertisements for home-secured loans. For open-end home-equity plan advertisements, the two most significant changes relate to the clear and conspicuous standard and the advertisement of introductory terms. For advertisements for closed-end credit secured by a dwelling, the three most significant changes relate to strengthening the clear and conspicuous standard for advertising disclosures, regulating the disclosure of rates and payments in advertisements to ensure that low introductory or “teaser” rates or payments are not given undue emphasis, and prohibiting certain acts or practices in advertisements as provided under Section 129(l)(2) of TILA. A. Advertising Rules for Open-end Home-equity Plans—§ 226.16 Overview The Board is proposing to amend the open-end home-equity plan advertising rules in § 226.16. The two most significant changes relate to the clear and conspicuous standard and the advertisement of introductory terms in home-equity plans. Each of these proposed changes is summarized below. First, the Board is proposing to revise the clear and conspicuous standard for home-equity plan advertisements, consistent with the approach taken in the advertising rules for consumer leases under Regulation M. *See* 12 CFR 213.7(b). New commentary provisions would clarify how the clear and conspicuous standard applies to advertisements of home-equity plans with introductory rates or payments, and to Internet, television, and oral advertisements of home-equity plans. The proposal would also allow alternative disclosures for television and radio advertisements for home-equity plans by revising the Board's earlier proposal for open-end plans that are not home-secured to apply to home-equity plans as well. *See* 12 CFR 226.16(f) *and* 72 FR 32948, 33064 (June 14, 2007). Second, the Board is proposing to amend the regulation and commentary to ensure that advertisements adequately disclose not only introductory plan terms, but also the rates and payments that will apply over the term of the loan. The proposed changes are modeled after proposed amendments to the advertising rules for open-end plans that are not home-secured. *See* 72 FR 32948, 33064 (June 14, 2007). The Board is also proposing changes to implement provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 which requires disclosure of the tax implications of certain home-equity plans. *See* Pub. L. No. 109-8, 119 Stat. 23. Other technical and conforming changes are also proposed. The Board is not proposing to extend to home-equity plan advertisements the prohibitions it proposes to apply to advertisements for closed-end credit secured by a dwelling. As discussed below in connection with its proposed changes to § 226.24, the Board is proposing to prohibit certain acts or practices connected with advertisements for closed-end mortgage credit under TILA § 129(l)(2). *See* discussion of § 226.24(i) below. Based on its review of advertising copy and outreach efforts, the Board has not identified similar misleading acts or practices in advertisements for home-equity plans. The Board seeks comment, however, on whether it should extend any or all of the prohibitions contained in the proposed § 226.24(i) to home-equity plans, or whether there are other acts or practices associated with advertisements for home-equity plans that should be prohibited. Current Statute and Regulation TILA Section 147, implemented by the Board in § 226.16(d), governs advertisements of open-end home-equity plans secured by the consumer's principal dwelling. 15 U.S.C. 1665b. The statute applies to the advertisement itself, and therefore, the statutory and regulatory requirements apply to any person advertising an open-end credit plan, whether or not they meet the definition of creditor. *See* comment 2(a)(2)-2. Under the statute, if an open-end credit advertisement sets forth, affirmatively or negatively, any of the specific terms of the plan, including any required periodic payment amount, then the advertisement must also clearly and conspicuously state:
(1)Any loan fee the amount of which is determined as a percentage of the credit limit and an estimate of the aggregate amount of other fees for opening the account;
(2)in any case in which periodic rates may be used to compute the finance charge, the periodic rates expressed as an annual percentage rate;
(3)the highest annual percentage rate which may be imposed under the plan; and
(4)any other information the Board may by regulation require. The specific terms of an open-end plan that “trigger” additional disclosures, which are commonly known as “triggering terms,” are the payment terms of the plan, or finance charges and other charges required to be disclosed under §§ 226.6(a) and 226.6(b). If an advertisement for a home-equity plan states a triggering term, the regulation requires that the advertisement also state the terms required by the statute. *See* 12 CFR 226.16(d)(1); *see also* comments 16(d)-1, and 16(d)-2. Discussion *Clear and conspicuous standard* . The Board is proposing to add comments 16-4 to 16-7 to clarify how the clear and conspicuous standard applies to advertisements for home-equity plans. Currently, comment 16-1 explains that advertisements for open-end credit are subject to a clear and conspicuous standard set out in § 226.5(a)(1). The Board is not prescribing specific rules regarding the format of advertisements. However, proposed comment 16-4 would elaborate on the requirement that certain disclosures about introductory rates or payments in advertisements for home-equity plans be prominent and in close proximity to the triggering terms in order to satisfy the clear and conspicuous standard when introductory rates or payments are advertised and the disclosure requirements of proposed § 226.16(d)(6) apply. The disclosures would be deemed to meet this requirement if they appear immediately next to or directly above or below the trigger terms, without any intervening text or graphical displays. Terms required to be disclosed with equal prominence to the introductory rate or payment would be deemed to meet this requirement if they appear in the same type size as the trigger terms. A more detailed discussion of the proposed requirements for introductory rates or payments is found below. The equal prominence and close proximity requirements of proposed § 226.16(d)(6) would apply to all visual text advertisements. However, comment 16-4 states that electronic advertisements that disclose introductory rates or payments in a manner that complies with the Board's recently amended rule for electronic advertisements under § 226.16(c) would be deemed to satisfy the clear and conspicuous standard. *See* 72 FR 63462 (Nov. 9, 2007). Under the rule, if an electronic advertisement provides the required disclosures in a table or schedule, any statement of triggering terms elsewhere in the advertisement must clearly direct the consumer to the location of the table or schedule. For example, a triggering term in an advertisement on an Internet Web site may be accompanied by a link that directly takes the consumer to the additional information. *See* comment 16(c)(1)-2. An electronic advertisement may require consumers to scroll down a page, or click a link, to access important rate or payment information under the current rule. For example, an electronic advertisement may state a low introductory payment and require the consumer to click a link to find out that the payment applies for only two years and the payments that will apply after that. Using links in this manner may permit Internet advertisements to continue to emphasize low, introductory “teaser” rates or payments, while de-emphasizing rates or payments that apply for the term of a plan, as sometimes occurs with the use of footnotes. However, the Board recognizes that electronic advertisements may be displayed on devices with small screens, such as on Internet-enabled cellphones or personal digital assistants, that might necessitate scrolling in order to view additional information. The Board seeks comment on whether it should amend the rules for electronic advertisements for home-equity plans to require that all information about rates or payments that apply for the term of the plan be stated in close proximity to introductory rates or payments in a manner that does not require the consumer to click a link to access the information. The Board also solicits comment on the costs and practical limitations, if any, of imposing this close proximity requirement on electronic advertisements. The Board is also proposing to interpret the clear and conspicuous standards for Internet, television, and oral advertisements of home-equity plans. Proposed comment 16-5 explains that disclosures in the context of visual text advertisements on the Internet must not be obscured by techniques such as graphical displays, shading, coloration, or other devices, and must comply with all other requirements for clear and conspicuous disclosures under § 226.16(d). Proposed comment 16-6 likewise explains that textual disclosures in television advertisements must not be obscured by techniques such as graphical displays, shading, coloration, or other devices, must be displayed in a manner that allows the consumer to read the information, and must comply with all other requirements for clear and conspicuous disclosures under § 226.16(d). Proposed comment 16-7 would explain that oral advertisements, such as by radio or television, must provide disclosures at a speed and volume sufficient for a consumer to hear and comprehend them. In this context, the word “comprehend” means that the disclosures must be intelligible to consumers, not that advertisers must ensure that consumers understand the meaning of the disclosures. The Board is also proposing to allow the use of a toll-free telephone number as an alternative to certain oral disclosures in television or radio advertisements. 226.16(d)(2)—Discounted and Premium Rates If an advertisement for a variable-rate home-equity plan states an initial annual percentage rate that is not based on the index and margin used to make later rate adjustments, the advertisement must also state the period of time the initial rate will be in effect, and a reasonably current annual percentage rate that would have been in effect using the index and margin. *See* 12 CFR 226.16(d)(2). The Board proposes to revise this section to require that the triggered disclosures be stated with equal prominence and in close proximity to the statement of the initial APR. The Board believes that this will enhance consumers' understanding of the cost of credit for the home-equity plan being advertised. Proposed comment 16(d)-6 would provide safe harbors for what constitutes a “reasonably current index and margin” as used in § 226.16(d)(2) as well as § 226.16(d)(6). Under the proposed comment, the time period during which an index and margin would be considered reasonably current would depend on the medium in which the advertisement was distributed. For direct mail advertisements, a reasonably current index and margin would be one that was in effect within 60 days before mailing. For advertisements in electronic form, a reasonably current index and margin would be one that was in effect within 30 days before the advertisement was sent to a consumer's e-mail address, or for advertisements made on an Internet Web site, when viewed by the public. For printed advertisements made available to the general public, a reasonably current index and margin would be one that was in effect within 30 days before printing. 226.16(d)(3)—Balloon Payment If an advertisement for a home-equity plan contains a statement about any minimum periodic payment, the advertisement must also state, if applicable, that a balloon payment may result. *See* 12 CFR 226.16(d)(3). The Board proposes to revise this section to clarify that only statements about the amount of any minimum periodic payment trigger the required disclosure, and to require that the disclosure of a balloon payment be equally prominent and in close proximity to the statement of a minimum periodic payment. Consistent with comment 5b(d)(5)(ii)-3, the Board proposes to clarify that the disclosure is triggered when an advertisement contains a statement of any minimum periodic payment and a balloon payment may result if only minimum periodic payments are made, even if a balloon payment is uncertain or unlikely. Additionally, the Board proposes to clarify that a balloon payment results if paying the minimum periodic payments would not fully amortize the outstanding balance by a specified date or time, and the consumer must repay the entire outstanding balance at such time. Current comment 16(d)-7 states that an advertisement for a plan where a balloon payment will occur when only minimum payments are made must also state the fact that a balloon payment will result (not merely that a balloon payment “may” result). The Board proposes to incorporate the language from comment 16(d)-7 into the text of § 226.16(d)(3) with technical revisions. The comment would be revised and renumbered as comment 16(d)-9. The required disclosures regarding balloon payments must be stated with equal prominence and in close proximity to the minimum periodic payment. The Board believes that this will enhance consumers' ability to notice and understand the potential financial impact of making only minimum payments. 226.16(d)(4)—Tax Implications Section 1302 of the Bankruptcy Act amends TILA Section 147(b) to require additional disclosures for advertisements that are disseminated in paper form to the public or through the Internet, relating to an extension of credit secured by a consumer's principal dwelling that may exceed the fair market value of the dwelling. Such advertisements must include a statement that the interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible for Federal income tax purposes. 15 U.S.C. 1665b(b). The statute also requires a statement that the consumer should consult a tax adviser for further information on the deductibility of the interest. The Bankruptcy Act also requires that disclosures be provided at the time of application in cases where the extension of credit may exceed the fair market value of the dwelling. *See* 15 U.S.C. 1637a(a)(13). The Board intends to implement the application disclosure portion of the Bankruptcy Act during its forthcoming review of closed-end and HELOC disclosures under TILA. However, the Board requested comment on the implementation of both the advertising and application disclosures under this provision of the Bankruptcy Act for open-end credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17, 2005). A majority of comments on this issue addressed only the application disclosure requirement, but some commenters specifically addressed the advertising disclosure requirement. One industry commenter suggested that the advertising disclosure requirement apply only in cases where the advertised product allows for the credit to exceed the fair market value of the dwelling. Other industry commenters suggested that the requirement apply only to advertisements for products that are intended to exceed the fair market value of the dwelling. The Board proposes to revise § 226.16(d)(4) and comment 16(d)-3 to implement TILA Section 147(b). The Board's proposal clarifies that the new requirements apply to advertisements for home-equity plans where the advertised extension of credit may, by its terms, exceed the fair market value of the dwelling. The Board seeks comment on whether the new requirements should only apply to advertisements that state or imply that the creditor provides extensions of credit greater than the fair market value of the dwelling. 226.16(d)(6)—Introductory Rates and Payments The Board is proposing to add § 226.16(d)(6) to address the advertisement of introductory rates and payments in advertisements for home-equity plans. The proposed rule provides that if an advertisement for a home-equity plan states an introductory rate or payment, the advertisement must use the term “introductory” or “intro” in immediate proximity to each mention of the introductory rate or payment. The proposed rule also provides that such advertisements must disclose the following information in a clear and conspicuous manner with each listing of the introductory rate or payment: the period of time during which the introductory rate or introductory payment will apply; in the case of an introductory rate, any annual percentage rate that will apply under the plan; and, in the case of an introductory payment, the amount and time periods of any payments that will apply under the plan. In variable-rate transactions, payments that will be determined based on application of an index and margin to an assumed balance shall be disclosed based on a reasonably current index and margin. Although introductory rates are addressed, in part, by § 226.16(d)(2), which deals with the advertisement of discounted and premium rates, § 226.16(d)(6) is broader because it is not limited to initial rates, but applies to any advertised rate that applies for a limited period of time. Proposed § 226.16(d)(6) is similar to the approach taken by the Board with regard to the advertisement of introductory rates for open-end (not home-secured) plans in the June 2007 proposal to amend the Regulation Z open-end advertising rules. *See* 72 FR 32948, 33064 (June 14, 2007). However, the June 2007 proposal would only apply to the advertisement of introductory rates, while this proposal would apply to the advertisement of both introductory rates and payments. 226.16(d)(6)(i)—Definitions The Board proposes to define the terms “introductory rate,” “introductory payment,” and “introductory period” in § 226.16(d)(6)(i). In a variable-rate plan, the term “introductory rate” means any annual percentage rate applicable to a home-equity plan that is not based on the index and margin that will be used to make rate adjustments under the plan, if that rate is less than a reasonably current annual percentage rate that would be in effect based on the index and margin that will be used to make rate adjustments under the plan. The term “introductory payment” means, in the case of a variable-rate plan, the amount of any payment applicable to a home-equity plan for an introductory period that is not derived from the index and margin that will be used to determine the amount of any other payments under the plan and, given an assumed balance, is less than any other payment that will be in effect under the plan based on a reasonably current application of the index and margin that will be used to determine the amount of such payments. For a non-variable-rate plan, the term “introductory payment” means the amount of any payment applicable to a home-equity plan for an introductory period if that payment is less than the amount of any other payments that will be in effect under the plan given an assumed balance. The term “introductory period” means a period of time, less than the full term of the loan, that the introductory rate or payment may be applicable. Proposed comment 16(d)-5.i clarifies how the concepts of introductory rates and introductory payments apply in the context of advertisements for variable-rate plans. Specifically, the proposed comment provides that if the advertised annual percentage rate or the advertised payment is based on the index and margin that will be used to make rate or payment adjustments over the term of the loan, then there is no introductory rate or introductory payment. On the other hand, if the advertised annual percentage rate, or the advertised payment, is not based on the index and margin that will be used to make rate or payment adjustments, and a reasonably current application of the index and margin would result in a higher annual percentage rate or, given an assumed balance, a higher payment, then there is an introductory rate or introductory payment. The proposed revisions generally assume that a single index and margin will be used to make rate or payment adjustments under the plan. The Board solicits comment on whether and to what extent multiple indexes and margins are used in home-equity plans and whether additional or different rules are needed for such products. Proposed comment 16(d)-5.v clarifies how the concept of introductory payments applies in the context of advertisements for non-variable-rate plans. Specifically, the proposed comment provides that if the advertised payment is calculated in the same way as other payments under the plan based on an assumed balance, the fact that the payment could increase solely if the consumer made an additional draw does not make the payment an introductory payment. For example, if a payment of $500 results from an assumed $10,000 draw, and the payment would increase to $1000 if the consumer made an additional $10,000 draw, the payment is not an introductory payment. 226.16(d)(6)(ii)—Stating the Term “Introductory” Proposed § 226.16(d)(6)(ii) would require creditors to state either the term ”introductory” or its commonly-understood abbreviation ”intro” in immediate proximity to each listing of the introductory rate or payment in an advertisement for a home-equity plan. Proposed comment 16(d)-5.ii clarifies that placing the word “introductory” or “intro” within the same sentence as the introductory rate or introductory payment satisfies the immediately proximate standard. 226.16(d)(6)(iii)—Stating the Introductory Period and Post-Introductory Rate or Payments Proposed § 226.16(d)(6)(iii) provides that if an advertisement states an introductory rate or introductory payment, it must also clearly and conspicuously disclose, with equal prominence and in close proximity to the introductory rate or payment, the following, as applicable: the period of time during which the introductory rate or introductory payment will apply; in the case of an introductory rate, any annual percentage rate that will apply under the plan; and, in the case of an introductory payment, the amount and time periods of any payments that will apply under the plan. In variable-rate transactions, payments that will be determined based on application of an index and margin to an assumed balance shall be disclosed based on a reasonably current index and margin. Proposed comment 16(d)-5.iii provides safe harbors for satisfying the closely proximate or equally prominent requirements of proposed § 226.16(d)(6)(iii). Specifically, the required disclosures will be deemed to be closely proximate to the introductory rate or payment if they are in the same paragraph as the introductory rate or payment. Information disclosed in a footnote will not be deemed to be closely proximate to the introductory rate or payment. Consumer testing of account-opening and other disclosures undertaken in conjunction with the Board's open-end Regulation Z proposal suggests that placing information in a footnote makes it much less likely that the consumer will notice it. The required disclosures will be deemed equally prominent with the introductory rate or payment if they are in the same type size as the introductory rate or payment. Proposed comment 16(d)-5.iv clarifies that the requirement to disclose the amount and time periods of any payments that will apply under the plan may require the disclosure of several payment amounts, including any balloon payments. The comment provides an example of a home-equity plan with several payment amounts over the repayment period to illustrate the disclosure requirements. Proposed comment 16(d)-6, which is discussed above, would provide safe harbor definitions for the phrase “reasonably current index and margin.” 226.16(d)(6)(iv)—Envelope Excluded Proposed § 226.16(d)(6)(iv) provides that the requirements of § 226.16(d)(6)(iii) do not apply to envelopes, or to banner advertisements and pop-up advertisements that are linked to an electronic application or solicitation provided electronically. In the Board's view, because banner advertisements and pop-up advertisements are used to direct consumers to more detailed advertisements, they are similar to envelopes in the direct mail context. 226.16(f)—Alternative Disclosures—Television or Radio Advertisements The Board is proposing to expand § 226.16(f) to allow for alternative disclosures of the information required for home-equity plans under § 226.16(d)(1), where applicable, consistent with its proposal for credit cards and other open-end plans. *See* proposed § 226.16(f) *and* 72 FR 32948, 33064 (June 14, 2007). The Board's proposed revision follows the general format of the Board's earlier proposal for alternative disclosures for oral television and radio advertisements. If a triggering term is stated in the advertisement, one option would be to state each of the disclosures required by current §§ 226.16(b)(1) and (d)(1) at a speed and volume sufficient for a consumer to hear and comprehend them. Another option would be for the advertisement to state orally the APR applicable to the home-equity plan, and the fact that the rate may be increased after consummation, and provide a toll-free telephone number that the consumer may call to receive more information. Given the space and time constraints on television and radio advertisements, the required disclosures may go unnoticed by consumers or be difficult for them to retain. Thus, providing an alternative means of disclosure may be more effective in many cases given the nature of the media. This approach is also similar to the approach taken in the advertising rules for consumer leases under Regulation M, which also allows the use of toll-free numbers in television and radio advertisements. *See* 12 CFR 213.7(f)(1)(ii). B. Advertising Rules for Closed-end Credit—§ 226.24 Overview The Board is proposing to amend the closed-end credit advertising rules in § 226.24 to address advertisements for home-secured loans. The three most significant changes relate to strengthening the clear and conspicuous standard for advertising disclosures, regulating the disclosure of rates and payments in advertisements to ensure that low introductory or “teaser” rates or payments are not given undue emphasis, and prohibiting certain acts or practices in advertisements as provided under Section 129(l)(2) of TILA, 15 U.S.C. 1639(l)(2). Each of these proposed changes is summarized below. First, the Board is proposing to add a provision setting forth the clear and conspicuous standard for all closed-end advertisements and a number of new commentary provisions applicable to advertisements for home-secured loans. The regulation would be revised to include a clear and conspicuous standard for advertising disclosures, consistent with the approach taken in the advertising rules for Regulation M. *See* 12 CFR 213.7(b). New commentary provisions would be added to clarify how the clear and conspicuous standard applies to rates or payments in advertisements for home-secured loans, and to Internet, television, and oral advertisements of home-secured loans. The proposal would also add a provision to allow alternative disclosures for television and radio advertisements that is modeled after a proposed revision to the advertising rules for open-end (not home-secured) plans. *See* 72 FR 32948, 33064 (June 14, 2007). Second, the Board is proposing to amend the regulation and commentary to address the advertisement of rates and payments for home-secured loans. The proposed revisions are designed to ensure that advertisements adequately disclose all rates or payments that will apply over the term of the loan and the time periods for which those rates or payments will apply. Many advertisements for home-secured loans place undue emphasis on low, introductory “teaser” rates or payments that will apply for a limited period of time. Such advertisements do not give consumers accurate or balanced information about the costs or terms of the products offered. The proposed revisions would also prohibit advertisements from disclosing an interest rate lower than the rate at which interest is accruing. Instead, the only rates that could be included in advertisements for home-secured loans are the APR and one or more simple annual rates of interest. Many advertisements for home-secured loans promote very low rates that do not appear to be the rates at which interest is accruing. The advertisement of interest rates lower than the rate at which interest is accruing is likely confusing for consumers. Taken together, the Board believes that the proposed changes regarding the disclosure of rates and payments in advertisements for home-secured loans will enhance the accuracy of advertising disclosures and benefit consumers. Third, pursuant to TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), the Board is proposing to prohibit seven specific acts or practices in connection with advertisements for home-secured loans that the Board finds to be unfair, deceptive, associated with abusive lending practices, or otherwise not in the interest of the borrower. *Bankruptcy Act changes* . The Board is also proposing several changes to clarify certain provisions of the closed-end advertising rules, including the scope of the certain triggering terms, and to implement provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requiring disclosure of the tax implications of home-secured loans. *See* Pub. L. No. 109-8, 119 Stat. 23. Technical and conforming changes to the closed-end advertising rules are also proposed. *Outreach* . The Board's staff conducted extensive research and outreach in connection with developing the proposed revisions to the closed-end advertising rules. Board staff collected and reviewed numerous examples of advertising copy for home-secured loans. Board staff also consulted with representatives of consumer and community groups and Federal Trade Commission staff to identify areas where the advertising disclosures could be improved, as well as to identify acts or practices connected with advertisements for home-secured loans that should be prohibited. This research and outreach indicated that many advertisements prominently disclose terms that apply to home-secured loans for a limited period of time, such as low introductory “teaser” rates or payments, while disclosing with much less prominence, often in a footnote, the rates or payments that apply over the full term of the loan. Board staff also identified through this research and outreach effort particular advertising acts or practices that can mislead consumers. Current Statute and Regulation TILA Section 144, implemented by the Board in § 226.24, governs advertisements of credit other than open-end plans. 15 U.S.C. 1664. TILA Section 144 thus applies to advertisements of closed-end credit, including advertisements for closed-end credit secured by a dwelling (also referred to as “home-secured loans”). The statute applies to the advertisement itself, and therefore, the statutory and regulatory requirements apply to any person advertising closed-end credit, whether or not such person meets the definition of creditor. *See* comment 2(a)(2)-2. Under the statute, if an advertisement states the rate of a finance charge, the advertisement must state the rate of that charge as an APR. In addition, closed-end credit advertisements that contain certain terms must also include additional disclosures. The specific terms of closed-end credit that “trigger” additional disclosures, which are commonly known as “triggering terms,” are
(1)the amount of the downpayment, if any,
(2)the amount of any installment payment,
(3)the dollar amount of any finance charge, and
(4)the number of installments or the period of repayment. If an advertisement for closed-end credit states a triggering term, then the advertisement must also state any downpayment, the terms of repayment, and the rate of the finance charged expressed as an APR. *See* 12 CFR 226.24(b)-(c); *see also* comments 24(b)-(c) (as redesignated to proposed §§ 226.24(c)-(d) and comments 24(c)-(d)). TILA Section 105(a) authorizes the Board to adopt regulations to ensure meaningful disclosure of credit terms so that consumers will be able to compare available credit terms and avoid the uninformed use of credit. 15 U.S.C. 1604(a). TILA Section 122 authorizes the Board to require that information, including the information required under Section 144, be disclosed in a clear and conspicuous manner. 15 U.S.C. 1632. TILA Section 129(l)(2) authorizes the Board to prohibit acts or practices in connection with mortgage loans that the Board finds to be unfair or deceptive. TILA Section 129(l)(2) also authorizes the Board to prohibit acts or practices in connection with the refinancing of mortgage loans that the Board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower. 15 U.S.C. 1639(l)(2). 226.24(b)—Clear and Conspicuous Standard The Board is proposing to add a clear and conspicuous standard in § 226.24(b) that would apply to all closed-end advertising. This provision would supplement, rather than replace, the clear and conspicuous standard that applies to all closed-end credit disclosures under Subpart C of Regulation Z and that requires all disclosures be in a reasonably understandable form. *See* 12 CFR 226.17(a)(1); comment 17(a)(1)-1. The new provision provides a framework for clarifying how the clear and conspicuous standard applies to advertisements that are not in writing or in a form that the consumer may keep, or that emphasize introductory rates or payments. Currently, comment 24-1 explains that advertisements for closed-end credit are subject to a clear and conspicuous standard based on § 226.17(a)(1). The existing comment would be renumbered as comment 24(b)-1 and revised to reference the proposed format requirements for advertisements of rates or payments for home-secured loans. The Board is not prescribing specific rules regarding the format of advertising disclosures generally. However, proposed comment 24(b)-2 would elaborate on the requirement that certain disclosures about rates or payments in advertisements for home-secured loans be prominent and in close proximity to other information about rates or payments in the advertisement in order to satisfy the clear and conspicuous standard and the disclosure requirements of proposed § 226.24(f). Terms required to be disclosed in close proximity to other rate or payment information would be deemed to meet this requirement if they appear immediately next to or directly above or below the trigger terms, without any intervening text or graphical displays. Terms required to be disclosed with equal prominence to other rate or payment information would be deemed to meet this requirement if they appear in the same type size as other rates or payments. A more detailed discussion of the proposed requirements for disclosing rates or payments is found below. The equal prominence and close proximity requirements of proposed § 226.24(f) would apply to all visual text advertisements. However, comment 24(b)-2 states that electronic advertisements that disclose rates or payments in a manner that complies with the Board's recently amended rule for electronic advertisements under current § 226.24(d) would be deemed to satisfy the clear and conspicuous standard. *See* 72 FR 63462 (Nov. 9, 2007). Under the rule, if an electronic advertisement provides the required disclosures in a table or schedule, any statement of triggering terms elsewhere in the advertisement must clearly direct the consumer to the location of the table or schedule. For example, a triggering term in an advertisement on an Internet Web site may be accompanied by a link that directly takes the consumer to the additional information. *See* comment 24(d)-4. The Board recognizes that electronic advertisements may be displayed on devices with small screens that might necessitate scrolling to view additional information. The Board seeks comment, however, on whether it should amend the rules for electronic advertisements for home-secured loans to require that all information about rates or payments that apply for the term of the loan be stated in close proximity to other rates or payments in a manner that does not require the consumer to click a link to access the information. The Board also solicits comment on the costs and practical limitations, if any, of imposing this close proximity requirement on electronic advertisements. The Board is also proposing to interpret the clear and conspicuous standards for Internet, television, and oral advertisements of home-secured loans. Proposed comment 24(b)-3 explains that disclosures in the context of visual text advertisements on the Internet must not be obscured by techniques such as graphical displays, shading, coloration, or other devices, and must comply with all other requirements for clear and conspicuous disclosures under § 226.24. Proposed comment 24(b)-4 likewise explains that visual text advertisements on television must not be obscured by techniques such as graphical displays, shading, coloration, or other devices, must be displayed in a manner that allows a consumer to read the information required to be disclosed, and must comply with all other requirements for clear and conspicuous disclosures under § 226.24. Proposed comment 24(b)-5 would explain that oral advertisements, such as by radio or television, must provide the disclosures at a speed and volume sufficient for a consumer to hear and comprehend them. In this context, the word “comprehend” means that the disclosures be intelligible to consumers, not that advertisers must ensure that consumers understand the meaning of all of the disclosures. Proposed § 226.24(g) provides an alternative method of disclosure for television or radio advertisements when trigger terms are stated orally and is discussed more fully below. 226.24(c)—Advertisement of Rate of Finance Charge *Disclosure of simple annual rate or periodic rate.* If an advertisement states a rate of finance charge, it shall state the rate as an APR. *See* 12 CFR 226.24(b) (as redesignated to proposed § 226.24(c)). An advertisement may also state, in conjunction with and not more conspicuously than the APR, a simple annual rate or periodic rate that is applied to an unpaid balance. The Board proposes to renumber § 226.24(b) as § 226.24(c), and revise it. The revised rule would provide that advertisements for home-secured loans shall not state any rate other than an APR, except that a simple annual rate that is applied to an unpaid balance may be stated in conjunction with, but not more conspicuously than, the APR. Advertisement of a periodic rate, other than the simple annual rate, or any other rates would no longer be permitted in connection with home-secured loans. Comment 24(b)-2 would be renumbered as comment 24(c)-2 and revised to clarify that a simple annual rate or periodic rate is the rate at which interest is accruing. A rate lower than the rate at which interest is accruing, such as an effective rate, payment rate, or qualifying rate, is not a simple annual rate or periodic rate. The example in renumbered comment 24(c)-2 also would be revised to reference proposed § 226.24(f), which contains requirements regarding the disclosure of rates and payments in advertisements for home-secured loans. *Buydowns.* Comment 24(b)-3, which addresses “buydowns,” would be renumbered as comment 24(c)-3 and revised. A buydown is where a seller or creditor offers a reduced interest rate and reduced payments to a consumer for a limited period of time. Comment 24(c)-3 allows the seller or creditor, in the case of a buydown, to advertise the reduced simple interest rate, the limited term to which the reduced rate applies, and the simple interest rate applicable to the balance of the term. The advertisement may show the effect of the buydown agreement on the payment schedule for the buydown period. The Board proposes to revise the comment to explain that additional disclosures would be required when an advertisement includes information showing the effect of the buydown agreement on the payment schedule. Such advertisements would have to provide the disclosures required by current § 226.24(c)(2) because showing the effect of the buydown agreement on the payment schedule is a statement about the amount of any payment, and thus is a triggering term. *See* 12 CFR 226.24(c)(1)(iii). In these circumstances, the additional disclosures are necessary for consumers to understand the costs of the loan and the terms of repayment. Consistent with these changes, the examples of statements about buydowns that an advertisement may make without triggering additional disclosures would be removed. *Effective rates.* The Board is proposing to delete current comment 24(b)-4. The current comment allows the advertisement of three rates: the APR; the rate at which interest is accruing; and an interest rate lower than the rate at which interest is accruing, which may be referred to as an effective rate, payment rate, or qualifying rate. The comment also contains an example of how to disclose the three rates. The Board is proposing to delete this comment for the reasons stated below. First, the disclosure of three rates is unnecessarily confusing for consumers and the disclosure of an interest rate lower than the rate at which interest is accruing does not provide meaningful information to consumers about the cost of credit. Second, when the effective rates comment was adopted in 1982, the Board noted that the comment was designed “to address the advertisement of special financing involving ‘effective rates,' ‘payment rates,' or ‘qualifying rates.” ' *See* 47 FR 41338, 41342 (Sept. 20, 1982). At that time, when interest rates were quite high, these terms were used in connection with graduated-payment mortgages. Today, however, some advertisers appear to rely on this comment when advertising rates for a variety of home-secured loans, such as negative amortization loans and option ARMs. In these circumstances, the advertisement of rates lower than the rate at which interest is accruing for these products is not helpful to consumers, particularly consumers who may not fully understand how these non-traditional home-secured loans work. *Discounted variable-rate transactions.* Comment 24(b)-5 would be renumbered as comment 24(c)-4 and revised to explain that an advertisement for a discounted variable-rate transaction which advertises a reduced or discounted simple annual rate must show with equal prominence and in close proximity to that rate, the limited term to which the simple annual rate applies and the annual percentage rate that will apply after the term of the initial rate expires. The comment would also be revised to explain that additional disclosures would be required when an advertisement includes information showing the effect of the discount on the payment schedule. Such advertisements would have to provide the disclosures required by current § 226.24(c)(2). Showing the effect of the discount on the payment schedule is a statement about the number of payments or the period of repayment, and thus is a triggering term. *See* 12 CFR 226.24(c)(1)(ii). In these circumstances, the additional disclosures are necessary for consumers to understand the costs of the loan and the terms of repayment. Consistent with these changes, the examples of statements about discounted variable-rate transactions that an advertisement may make without triggering additional disclosures would be removed. 226.24(d)—Advertisement of Terms That Require Additional Disclosures *Required disclosures.* The Board proposes to renumber § 226.24(c) as § 226.24(d) and revise it. The proposed rule would clarify the meaning of the “terms of repayment” required to be disclosed. Specifically, the terms of repayment must reflect “the repayment obligations over the full term of the loan, including any balloon payment,” not just the repayment terms that will apply for a limited period of time. This proposed revision is consistent with other proposed changes and is designed to ensure that advertisements for closed-end credit, especially home-secured loans, adequately disclose the terms that will apply over the full term of the loan, not just for a limited period of time. Consistent with these proposed changes, comment 24(c)(2)-2 would be renumbered as comment 24(d)(2)-2 and revised. Commentary regarding advertisement of loans that have a graduated-payment feature would be removed from comment 24(d)(2)-2. In advertisements for home-secured loans where payments may vary because of the inclusion of mortgage insurance premiums, the comment would explain that the advertisement may state the number and timing of payments, the amounts of the largest and smallest of those payments, and the fact that other payments will vary between those amounts. In advertisements for home-secured loans with one series of low monthly payments followed by another series of higher monthly payments, the comment would explain that the advertisement may state the number and time period of each series of payments and the amounts of each of those payments. However, the amount of the series of higher payments would have to be based on the assumption that the consumer makes the lower series of payments for the maximum allowable period of time. For example, if a consumer has the option of making interest-only payments for two years and an advertisement states the amount of the interest-only payment, the advertisement must state the amount of the series of higher payments based on the assumption that the consumer makes the interest-only payments for the full two years. The Board believes that without these disclosures consumers may not fully understand the cost of the loan or the payment terms that may result once the higher payments take effect. The proposed revisions to renumbered comment 24(d)(2)-2 would apply to all closed-end advertisements. The Board believes that the terms of repayment for any closed-end credit product should be disclosed for the full term of the loan, not just for a limited period of time. The Board also does not believe that this proposed change will significantly impact advertising practices for closed-end credit products such as auto loans and installment loans that ordinarily have shorter terms than home-secured loans. New comment 24(d)(2)-3 would be added to address the disclosure of balloon payments as part of the repayment terms. The proposed comment notes that in some transactions, a balloon payment will occur when the consumer only makes the minimum payments specified in an advertisement. A balloon payment results if paying the minimum payments does not fully amortize the outstanding balance by a specified date or time, usually the end of the term of the loan, and the consumer must repay the entire outstanding balance at such time. The proposed comment explains that if a balloon payment will occur if the consumer only makes the minimum payments specified in an advertisement, the advertisement must state with equal prominence and in close proximity to the minimum payment statement the amount and timing of the balloon payment that will result if the consumer makes only the minimum payments for the maximum period of time that the consumer is permitted to make such minimum payments. The Board believes that disclosure of the balloon payment in advertisements that promote such minimum payments is necessary to inform consumers about the repayment terms that will apply over the full term of the loan. Current comments 24(c)(2)-3 and 24(c)(2)-4 would be renumbered as comments 24(d)(2)-4 and 24(d)(2)-5 without substantive change. 226.24(e)—Catalogs or Other Multiple-Page Advertisements; Electronic Advertisements The Board is proposing to renumber § 226.24(d) as § 226.24(e) and make technical changes to reflect the renumbering of certain sections of the regulation and commentary. 226.24(f)—Disclosure of Rates and Payments in Advertisements for Credit Secured by a Dwelling The Board is proposing to add a new subsection
(f)to § 226.24 to address the disclosure of rates and payments in advertisements for home-secured loans. The primary purpose of these provisions is to ensure that advertisements do not place undue emphasis on low introductory “teaser” rates or payments, but adequately disclose the rates and payments that will apply over the term of the loan. The specific provisions of proposed subsection
(f)are discussed below. 226.24(f)(1)—Scope Proposed § 226.24(f)(1) provides that the new section applies to any advertisement for credit secured by a dwelling, other than television or radio advertisements, including promotional materials accompanying applications. The Board does not believe it is feasible to apply the requirements of this section, notably the close proximity and prominence requirements, to oral advertisements. However, the Board requests comment on whether these or different standards should be applied to oral advertisements for home-secured loans. 226.24(f)(2)—Disclosure of Rates Proposed § 226.24(f)(2) addresses the disclosure of rates. Under the proposed rule, if an advertisement for credit secured by a dwelling states a simple annual rate of interest and more than one simple annual rate of interest will apply over the term of the advertised loan, the advertisement must disclose the following information in a clear and conspicuous manner:
(a)Each simple annual rate of interest that will apply. In variable-rate transactions, a rate determined by an index and margin must be disclosed based on a reasonably current index and margin;
(b)the period of time during which each simple annual rate of interest will apply; and
(c)the annual percentage rate for the loan. If the rate is variable, the annual percentage rate must comply with the accuracy standards in §§ 226.17(c) and 226.22. Proposed comment 24(f)-4 would specifically address how this requirement applies in the context of advertisements for variable-rate transactions. For such transactions, if the simple annual rate that applies at consummation is based on the index and margin that will be used to make subsequent rate adjustments over the term of the loan, then there is only one simple annual rate and the requirements of § 226.24(f)(2) do not apply. If, however, the simple annual rate that applies at consummation is not based on the index and margin that will be used to make subsequent rate adjustments over the term of the loan, then there is more than one simple annual rate and the requirements of § 226.24(f)(2) apply. The proposed revisions generally assume that a single index and margin will be used to make rate or payment adjustments under the loan. The Board solicits comment on whether and to what extent multiple indexes and margins are used in home-secured loans and whether additional or different rules are needed for such products. Finally, the proposed rule establishes a clear and conspicuous standard for the disclosure of rates in advertisements for home-secured loans. Under this standard, the information required to be disclosed by § 226.24(f)(2) must be disclosed with equal prominence and in close proximity to any advertised rate that triggered the required disclosures, except that the annual percentage rate may be disclosed with greater prominence than the other information. Proposed comment 24(f)-1 would provide safe harbors for compliance with the equal prominence and close proximity standards. Proposed comment 24(f)-2 provides a cross-reference to comment 24(b)-2, which provides further guidance on the clear and conspicuous standard in this context. 226.24(f)(3)—Disclosure of Payments Proposed § 226.24(f)(3) addresses the disclosure of payments. Under the proposed rule, if an advertisement for credit secured by a dwelling states the amount of any payment, the advertisement must disclose the following information in a clear and conspicuous manner:
(a)The amount of each payment that will apply over the term of the loan, including any balloon payment. In variable-rate transactions, payments that will be determined based on application of an index and margin must be disclosed based on a reasonably current index and margin;
(b)the period of time during which each payment will apply; and
(c)in an advertisement for credit secured by a first lien on a dwelling, the fact that the payments do not include amounts for taxes and insurance premiums, if applicable, and that the actual payment obligation will be greater. These requirements are in addition to the disclosure requirements of current § 226.24(c). Proposed comment 24(f)(3)-2 would specifically address how this requirement applies in the context of advertisements for variable-rate transactions. For such transactions, if the payment that applies at consummation is based on the index and margin that will be used to make subsequent payment adjustments over the term of the loan, then there is only one payment that must be disclosed and the requirements of § 226.24(f)(3) do not apply. If, however, the payment that applies at consummation is not based on the index and margin that will be used to make subsequent payment adjustments over the term of the loan, then there is more than one payment that must be disclosed and the requirements of § 226.24(f)(3) apply. The proposed rule establishes a clear and conspicuous standard for the disclosure of payments in advertisements for home-secured loans. Under this standard, the information required to be disclosed under § 226.24(f)(3) regarding the amounts and time periods of payments must be disclosed with equal prominence and in close proximity to any advertised payment that triggered the required disclosures. The information required to be disclosed under § 226.24(f)(3) regarding the fact that taxes and insurance premiums are not included in the payment must be prominently disclosed and in close proximity to the advertised payments. The Board believes that requiring the disclosure about taxes and insurance premiums to be equally prominent could distract consumers from the key payment and time period information. As noted above, proposed comment 24(f)-1 would provide safe harbors for compliance with the equal prominence and close proximity standards. Proposed comment 24(f)-2 provides a cross-reference to the comment 24(b)-2, which provides further guidance regarding the application of the clear and conspicuous standard in this context. Proposed comment 24(f)-3 clarifies how the rules on disclosures of rates and payments in advertisements apply to the use of comparisons in advertisements. This comment covers both rate and payment comparisons, but in practice, comparisons in advertisements usually focus on payments. Proposed comment 24(f)(3)-1 clarifies that the requirement to disclose the amounts and time periods of all payments that will apply over the term of the loan may require the disclosure of several payment amounts, including any balloon payment. The comment provides an illustrative example. Proposed comment 24(f)-5 would provide safe harbors for what constitutes a “reasonably current index and margin” as used in § 226.24(f). Under the proposed comment, the time period during which an index and margin would be considered reasonably current would depend on the medium in which the advertisement was distributed. For direct mail advertisements, a reasonably current index and margin would be one that was in effect within 60 days before mailing. For advertisements in electronic form, a reasonably current index and margin would be one that was in effect within 30 days before the advertisement was sent to a consumer's e-mail address, or for advertisements made on an Internet Web site, when viewed by the public. For printed advertisements made available to the general public, a reasonably current index and margin would be one that was in effect within 30 days before printing. 226.24(f)(4)—Envelope Excluded Proposed § 226.24(f)(4) provides that the requirements of §§ 226.24(f)(2) and
(3)do not apply to envelopes or to banner advertisements and pop-up advertisements that are linked to an electronic application or solicitation provided electronically. In the Board's view, banner advertisements and pop-up advertisements are similar to envelopes in the direct mail context. 226.24(g)—Alternative Disclosures—Television or Radio Advertisements The Board is proposing to add a new § 226.24(g) to allow alternative disclosures to be provided in oral television and radio advertisements pursuant to its authority under TILA §§ 105(a), 122, and 144. One option would be to state each of the disclosures required by current § 226.24(c)(2) at a speed and volume sufficient for a consumer to hear and comprehend them if a triggering term is stated in the advertisement. Another option would be for the advertisement to state orally the APR applicable to the loan, and the fact that the rate may be increased after consummation, if applicable, at a speed and volume sufficient for a consumer to hear and comprehend them. However, instead of orally disclosing the required information about the amount or percentage of the downpayment and the terms of repayment, the advertisement could provide a toll-free telephone number that the consumer may call to receive more information. Given the space and time constraints on television and radio advertisements, the required disclosures may go unnoticed by consumers or be difficult for them to retain. Thus, providing an alternative means of disclosure may be more effective in many cases given the nature of television and radio media. This approach is consistent with the approach taken in the proposed revisions to the advertising rules for open-end plans (other than home-secured plans). *See* 72 FR 32948, 33064 (June 14, 2007). This approach is also similar, but not identical, to the approach taken in the advertising rules under Regulation M. *See* 12 CFR 213.7(f). Section 213.7(f)(1)(ii) of Regulation M permits a leasing advertisement made through television or radio to direct the consumer to a written advertisement in a publication of general circulation in a community served by the media station. The Board has not proposed this option because it may not provide sufficient, readily-accessible information to consumers who are shopping for a home-secured loan and because advertisers, particularly those advertising on a regional or national scale, are not likely to use this option. 226.24(h)—Tax Implications Section 1302 of the Bankruptcy Act amends TILA Section 144(e) to address advertisements that are disseminated in paper form to the public or through the Internet, as opposed to by radio or television, and that relate to an extension of credit secured by a consumer's principal dwelling that may exceed the fair market value of the dwelling. Such advertisements must include a statement that the interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible for Federal income tax purposes. 15 U.S.C. 1664(e). For such advertisements, the statute also requires inclusion of a statement that the consumer should consult a tax adviser for further information on the deductibility of the interest. The Bankruptcy Act also requires that disclosures be provided at the time of application in cases where the extension of credit may exceed the fair market value of the dwelling. *See* 15 U.S.C. 1638(a)(15). The Board intends to implement the application disclosure portion of the Bankruptcy Act during its forthcoming review of closed-end and HELOC disclosures under TILA. However, the Board requested comment on the implementation of both the advertising and application disclosures under this provision of the Bankruptcy Act for open-end credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17, 2005). A majority of comments on this issue addressed only the application disclosure requirement, but some commenters specifically addressed the advertising disclosure requirement. One industry commenter suggested that the advertising disclosure requirement apply only in cases where the advertised product allows for the credit to exceed the fair market value of the dwelling. Other industry commenters suggested that the requirement apply only to advertisements for products that are intended to exceed the fair market value of the dwelling. The Board proposes to add § 226.24(h) and comment 24(h)-1 to implement TILA Section 144(e). The Board's proposal clarifies that the new requirements apply to advertisements for home-secured loans where the advertised extension of credit may, by its terms, exceed the fair market value of the dwelling. The Board seeks comment on whether the new requirements should only apply to advertisements that state or imply that the creditor provides extensions of credit greater than the fair market value of the dwelling. 226.24(i)—Prohibited Acts or Practices in Mortgage Advertisements Section 129(l)(2) of TILA gives the Board the authority to prohibit acts or practices in connection with mortgage loans that it finds to be unfair or deceptive. Section 129(l)(2) of TILA also gives the Board the authority to prohibit acts or practices in connection with the refinancing of mortgage loans that the Board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower. 15 U.S.C. 1639(l)(2). Through an extensive review of advertising copy and other outreach efforts described above, Board staff identified a number of acts or practices connected with mortgage and mortgage refinancing advertising that appear to be inconsistent with the standards set forth in Section 129(l)(2) of TILA. Accordingly, the Board is proposing to add § 226.24(i) to prohibit seven acts or practices connected with advertisements of home-secured loans. The Board solicits comment on the appropriateness of the seven proposed prohibitions and whether any additional acts or practices should be prohibited by the regulation. 226.24(i)(1)—Misleading Advertising for “Fixed” Rates, Payments or Loans Advertisements for home-secured loans often refer to a rate or payment, or to the credit transaction, as “fixed.” Such a reference is appropriate when used to denote a fixed-rate mortgage in which the rate or payment amounts do not change over the full term of the loan. Indeed, some credit counselors often encourage consumers to shop only for fixed-rate mortgages. The Board has found that some advertisements also use the term “fixed” in connection adjustable-rate mortgages, or with fixed-rate mortgages that include low initial payments that will increase. Some of these advertisements make clear that the rate or payment is only “fixed” for a defined period of time, but after that the rate or payment may increase. For example, one advertisement reviewed prominently discloses that the product is an “Adjustable-Rate Mortgage” in large type, and clearly discloses in standard type that the rate is “fixed” for the first three, five, or seven years depending upon the product selected and may increase after that. However, other advertisements do not adequately disclose that the interest rate or payment amounts are “fixed” only for a limited period of time, rather than for the full term of the loan. For example, some advertisements reviewed prominently refer to a “30-Year Fixed Rate Loan” or “Fixed Pay Rate Loan” on the first page. A footnote on the last page of the advertisements discloses in small type that the loan product is a payment option ARM in which the fully indexed rate and fully amortizing payment will be applied after the first five years. The Board finds that the use of the word “fixed” in this manner can mislead consumers into believing that the advertised product is a fixed-rate mortgage with rates and payments that will not change during the term of the loan. Proposed § 226.24(i)(1) would prohibit the use of the term “fixed” in advertisements for credit secured by a dwelling, unless certain conditions are satisfied. The proposal would prohibit the use of the term “fixed” in advertisements for variable-rate transactions, unless two conditions are satisfied. First, the phrase “Adjustable-Rate Mortgage” or “Variable-Rate Mortgage” must appear in the advertisement before the first use of the word “fixed” and be at least as conspicuous as every use of the word “fixed.” Second, each use of the word “fixed” must be accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed and the fact that the rate may vary or the payment may increase after that period. Based on the advertising copy reviewed, particularly the first example described above, the Board believes there are legitimate and appropriate circumstances for using the term “fixed,” even in advertisements for variable-rate transactions. Therefore, the Board is not proposing an absolute ban on use of the term “fixed” in advertisements for variable-rate transactions. The Board believes that this more targeted approach will curb deceptive advertising practices. The proposal would also prohibit the use of the term “fixed” to refer to the advertised payment in advertisements solely for transactions other than variable-rate transactions where the advertised payment may increase ( *i.e.* , fixed-rate mortgage transactions with an initial lower payment that will increase), unless each use of the word “fixed” to refer to the advertised payment is accompanied by an equally prominent and closely proximate statement of the time period for which the payment is fixed and the fact that the payment may increase after that period. Finally, the proposal would prohibit the use of the term “fixed” in advertisements for both variable-rate transactions and non-variable-rate transactions, unless certain conditions are satisfied. First, the phrase “Adjustable-Rate Mortgage,” “Variable-Rate Mortgage,” or “ARM” must appear in the advertisement with equal prominence as any use of the word “fixed.” Second, each use of the term “fixed” to refer to a rate, payment, or to the credit transaction, must clearly refer solely to transactions for which rates are fixed and, if used to refer to an advertised payment, be accompanied by an equally prominent and closely proximate statement of the time period for which the advertised payment is fixed and the fact that the payment will increase after that period. Third, if the term “fixed” refers to the variable-rate transactions, it must be accompanied by an equally prominent and closely proximate statement of a time period for which the rate or payment is fixed, and the fact that the rate may vary or the payment may increase after that period. The Board believes that this approach balances the need to protect consumers from misleading advertisements about the terms that are “fixed,” while ensuring that advertisers can continue to use the term “fixed” for legitimate, non-deceptive purposes in advertisements for home-secured loans, including variable-rate transactions. 226.24(i)(2)—Misleading Comparisons in Advertisements Some advertisements for home-secured loans make comparisons between an actual or hypothetical consumer's current rate or payment obligations and the rates or payments that would apply if the consumer obtains the advertised product. The advertised rates or payments used in these comparisons frequently are low introductory “teaser” rates or payments that will not apply over the full term of the loan, and do not include amounts for taxes or insurance premiums. In addition, the current rate or payment obligations used in these comparisons frequently include not only the consumer's mortgage payment, but also possible payments for short-term, non-home secured, or revolving credit obligations, such as auto loans, installment loans, or credit card debts. The Board finds that making comparisons in advertisements can be misleading if the advertisement compares the consumer's current payments or rates to payments or rates available for the advertised product that will only be in effect for a limited period of time, rather than for the term of the loan. Similarly, the Board finds that such comparisons can be misleading if the consumer's current payments include amounts for taxes and insurance premiums, but the payments for the advertised product do not include those amounts. These practices make comparison between the consumer's current obligations and the lower advertised rates or payments misleading. Proposed § 226.24(i)(2) would prohibit any advertisement for credit secured by a dwelling from making any comparison between an actual or hypothetical consumer's current payments or rates and the payment or simple annual rate that will be available under the advertised product for less than the term of the loan, unless two conditions are satisfied. First, the comparison must include with equal prominence and in close proximity to the “teaser” payment or rate, all applicable payments or rates for the advertised product that will apply over the term of the loan and the period of time for which each applicable payment or simple annual rate will apply. Second, the advertisement must include a prominent statement in close proximity to the advertised payments that such payments do not include amounts for taxes and insurance premiums, if applicable. In the case of advertisements for variable-rate transactions where the advertised payment or simple annual rate is based on the index and margin that will be used to make subsequent rate or payment adjustments over the term of the loan, the comparison must include:
(a)An equally prominent statement in close proximity to the advertised payment or rate that the payment or rate is subject to adjustment and the time period when the first adjustment will occur; and
(b)a prominent statement in close proximity to the advertised payment that the payment does not include amounts for taxes and insurance premiums, if applicable. Proposed comment 24(i)-1 would clarify that a misleading comparison includes a claim about the amount that a consumer may save under the advertised product. For example, a statement such as “save $600 per month on a $500,000 loan” constitutes an implied comparison between the advertised product's payment and a consumer's current payment. The Board is not proposing to prohibit comparisons that take into account the consolidation of non-mortgage credit, such as auto loans, installment loans, or revolving credit card debt, into a single, home-secured loan. Debt consolidation can be beneficial for some consumers. Prohibiting the use of comparisons in advertisements that are based solely on low introductory “teaser” rates or payments should address abusive practices in advertisements focused on debt consolidation. The Board solicits comment on whether comparisons based on the assumed refinancing of non-mortgage debt into a new home-secured loan are associated with abusive lending practices or otherwise not in the interest of the borrower and should therefore be prohibited as well. 226.24(i)(3)—Misrepresentations About Government Endorsement Some advertisements for home-secured loans characterize the products offered as “government loan programs,” “government-supported loans,” or otherwise endorsed or sponsored by a federal or state government entity, even though the advertised products are not government-supported loans, such as FHA or VA loans, or otherwise endorsed or sponsored by any federal, state, or local government entity. The Board finds that such advertisements can mislead consumers into believing that the government is guaranteeing, endorsing, or supporting the advertised loan product. Proposed § 226.24(i)(3) would prohibit such statements unless the advertisement is for an FHA loan, VA loan, or similar loan program that is, in fact, endorsed or sponsored by a federal, state, or local government entity. Proposed comment 24(i)-2 illustrates that a misrepresentation about government endorsement includes a statement that the federal Community Reinvestment Act entitles the consumer to refinance his or her mortgage at the new low rate offered in the advertisement is prohibited because it conveys to the consumer a misleading impression that the advertised product is endorsed or sponsored by the federal government. 226.24(i)(4)—Misleading Use of the Current Mortgage Lender's Name Some advertisements for home-secured loans prominently display the name of the consumer's current mortgage lender, while failing to disclose or to disclose adequately the fact that the advertisement is by a mortgage lender that is not associated with the consumer's current lender. The Board finds that such advertisements may mislead consumers into believing that their current lender is offering the loan advertised or that the loan terms stated in the advertisement constitute a reduction in the consumer's payment amount or rate, rather than an offer to refinance the current loan with a different creditor. Proposed § 226.24(i)(4) would prohibit any advertisement for a home-secured loan, such as a letter, that is not sent by or on behalf of the consumer's current lender from using the name of the consumer's current lender, unless the advertisement also discloses with equal prominence:
(a)The name of the person or creditor making the advertisement; and
(b)a clear and conspicuous statement that the person making the advertisement is not associated with, or acting on behalf of, the consumer's current lender. 226.24(i)(5)—Misleading Claims of Debt Elimination Some advertisements for home-secured loans include statements that promise to eliminate, cancel, wipe-out, waive, or forgive debt. The Board finds that such advertisements can mislead consumers into believing that they are entering into a debt forgiveness program rather than merely replacing one debt obligation with another. Proposed § 226.24(i)(5) would prohibit advertisements for credit secured by a dwelling that offer to eliminate debt, or waive or forgive a consumer's existing loan terms or obligations to another creditor. Proposed comment 24(i)-3 provides examples of claims that would be prohibited. These include the following claims: “Wipe-Out Personal Debts!”, “New DEBT-FREE Payment”, “Set yourself free; get out of debt today”, “Refinance today and wipe your debt clean!”, “Get yourself out of debt * * * Forever!”, and, in the context of an advertisement referring to a consumer's existing obligations to another creditor, “Pre-payment Penalty Waiver.” The proposed comment would also clarify that this provision does not prohibit an advertisement for a home-secured loan from claiming that the advertised product may reduce debt payments, consolidate debts, or shorten the term of the debt. 226.24(i)(6)—Misleading Claims Suggesting a Fiduciary or Other Relationship Some advertisements for home-secured loans attempt to create the impression that the mortgage broker or lender, its employees, or its subcontractors, have a fiduciary relationship with the consumer. The Board finds that such advertisements may mislead consumers into believing that the broker or lender will consider only the consumer's best interest in offering a mortgage loan to the consumer, when, in fact, the broker or lender may be considering its own interests. Proposed § 226.24(i)(6) would prohibit advertisements for credit secured by a dwelling from using the terms “counselor” or “financial advisor” to refer to a for-profit mortgage broker or lender, its employees, or persons working for the broker or lender that are involved in offering, originating or selling mortgages. The Board recognizes that counselors and financial advisors do play a legitimate role in assisting consumers in selecting appropriate home-secured loans. Nothing in this rule would prohibit advertisements for bona fide consumer credit counseling services, such as counseling services provided by non-profit organizations, or bona fide financial advisory services, such as services provided by certified financial planners. 226.24(i)(7)—Misleading Foreign-Language Advertisements Some advertisements for home-secured loans are targeted to non-English speaking consumers. In general, this is an appropriate means of promoting home ownership or offering loans to under-served, immigrant communities. In some of these advertisements, however, information about some of the trigger terms or required disclosures, such as a low introductory “teaser” rate or payment, is provided in a foreign language, while information about other trigger terms or required disclosures, such as the fully-indexed rate or fully amortizing payment, is provided only in English. The Board finds that this practice can mislead non-English speaking consumers who may not be able to comprehend the important English-language disclosures. Proposed § 226.24(i)(7) would prohibit advertisements for home-secured loans from providing information about some trigger terms or required disclosures, such as an initial rate or payment, only in a foreign language, but providing information about other trigger terms or required disclosures, such as information about the fully-indexed rate or fully amortizing payment, only in English. Advertisements that provide all disclosures in both English and a foreign language or advertisements that are entirely in English or entirely in a foreign language would not be affected by this prohibition. XI. Mortgage Loan Disclosures A. Early Mortgage Loan Disclosures—§ 226.19 TILA Section 128(b)(1) provides that the primary closed-end disclosure (referred to in this subpart as the “mortgage loan disclosure”), which includes the annual percentage rate
(APR)and other material disclosures, must be delivered “before the credit is extended.” 15 U.S.C. 1638(b)(1). A separate rule applies to residential mortgage transactions subject to the Real Estate Settlement Procedures Act (RESPA) and requires that “good faith estimates” of the mortgage loan disclosure be made “before the credit is extended, or shall be delivered or placed in the mail not later than three business days after the creditor receives the consumer's written application, whichever is earlier.” 15 U.S.C. 1638(b)(2). The Board proposes to amend Regulation Z to extend the early mortgage loan disclosure requirement for residential mortgage transactions to other types of closed-end mortgage transactions, including mortgage refinancings, home equity loans, and reverse mortgages. Consistent with the existing requirement for residential mortgage transactions, this requirement would be limited to transactions secured by a consumer's principal dwelling. The Board also proposes to require that the early mortgage loan disclosure be delivered before the consumer pays a fee to any person for these transactions. The Board is proposing an exception to the fee restriction, however, for obtaining information on the consumer's credit history. This proposal is made pursuant to TILA Section 105(a), which mandates that the Board prescribe regulations to carry out TILA's purposes, and authorizes the Board to create such classifications, differentiations, or other provisions, and to provide for such adjustments and exceptions for any class of transactions, as in the judgment of the Board are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. 15 U.S.C. 1604(a). TILA Section 102(a) provides, in pertinent part, that the Act's purposes are to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit. 15 U.S.C. 1601(a). The proposal is intended to help consumers make informed use of credit and shop among available credit alternatives. Under the current rule, creditors need not deliver mortgage loan disclosures on non-purchase money mortgage transactions until consummation. By that time, consumers may not be in a position to make meaningful use of the disclosure. Once consumers have reached the settlement table, it is likely too late for them to use the disclosure to shop among mortgages or to inform themselves adequately of the terms of the loan. Consumers are presented at settlement with a large, often overwhelming, number of documents, and they may not reasonably be able to focus adequate attention on the mortgage loan disclosure. Moreover, by the time of loan consummation, consumers may feel committed to the loan because they are accessing their equity for an urgent need, or they have already paid substantial application fees. The mortgage loan disclosure that consumers would receive early in the application process under this proposal includes a payment schedule, which would illustrate any increases in payments over time. The disclosure also would include an APR that reflects the fully indexed rate in cases of hybrid and payment-option ARMs, which sometimes are marketed on the basis of only an initial, discounted rate or a temporary, minimum payment. Providing this information within three days of application, before the consumer has paid a fee, would help ensure that consumers would have a genuine opportunity to review the credit terms being offered; ensure that the terms are consistent with their understanding of the transaction; assess whether the terms meet their needs and are affordable; and decide whether to go through with the transaction or continue to shop among alternatives. Disclosure Before Fee Paid The Board proposes to require that all of the early mortgage loan disclosures be delivered before the consumer pays a fee to any person in connection with the consumer's application for a mortgage transaction. Consumers typically pay fees to apply for a mortgage loan, such as fees for a credit report and property appraisal, as well as nonspecific “application” fees. If the fee is significant, a consumer may feel constrained from shopping for alternatives. This risk is particularly high in the subprime market, where consumers often are cash-strapped and where limited price transparency may obscure the benefits of continuing to shop. See part II.C for a discussion of these points. The risk also applies to the prime market, where many consumers would find significant a fee of several hundred dollars such as the fee often imposed for an appraisal and other services. The proposed early disclosure obligation would be limited to fees paid in connection with an application for a mortgage transaction. This limitation is necessary because the obligation is triggered by a fee paid to any person, not just to the creditor. The Board seeks comment on whether further guidance is necessary to clarify what fees would be deemed in connection with an application. The Board is proposing an exception to the fee restriction, however, for obtaining information on the consumer's credit history. The proposed exception to the fee restriction recognizes that creditors generally cannot make accurate transaction-specific estimates without having considered the consumer's credit history. To require creditors to bear the cost of reviewing credit history with little assurance the customer will apply for a loan may be unduly burdensome and could undermine the utility of the disclosures. The proposed exception would allow creditors to recoup the bona fide and reasonable amount necessary to obtain a credit report or other, similar form of information on the consumer's credit history. The Board expects this proposal would impose additional costs on creditors, some of which may be passed on in part to consumers. Some creditors already deliver early mortgage loan disclosures on non-purchase money mortgages. Not all creditors, however, follow this practice, and those that do not would face increased costs, both one-time costs to modify their systems and ongoing costs to originate loans. The Board seeks comment on whether the benefits of this proposal outweigh these costs or other costs commenters identify. Corresponding changes also would be made to the staff commentary, and certain other conforming amendments to Regulation Z and the staff commentary also are proposed. B. Future Plans To Improve Disclosure The Board remains committed to its longstanding belief that better information in the mortgage market can improve competition and help consumers make better decisions. This proposal contains new rules to prevent incomplete or misleading mortgage loan advertisements and solicitations, and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them. The Board recognizes that these disclosures need to be updated to reflect the increased complexity of mortgage products. In early 2008, the Board will begin testing current TILA mortgage disclosures and potential revisions to these disclosures through one-on-one interviews with consumers. The Board expects that this testing will identify potential improvements for the Board to propose for public comment in a separate rulemaking. XII. Civil Liability and Remedies; Administrative Enforcement Consumer Remedies for Unfair, Deceptive, or Abusive Practices The restrictions on loan terms and lending practices in proposed §§ 226.35 and 226.36, as well as the advertising restrictions in proposed § 226.24(i), are based on the Board's authority under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). Consumers who bring timely actions against creditors for violations of these restrictions may be able to recover:
(i)Actual damages;
(ii)statutory damages in an individual action of up to $2,000 or, in a class action, total statutory damages for the class of up to $500,000 or one percent of the creditor's net worth, whichever is less;
(iii)special statutory damages equal to the sum of all finance charges and fees paid by the consumer; and
(iv)court costs and attorney fees. TILA Section 130(a), 15 U.S.C. 1640(a). 72 72 Section 130(a), 15 U.S.C. 1640(a), authorizes recovery of amounts of types (i), (ii), and
(iv)from a creditor for a failure to comply with any requirement imposed under Chapter 2, which includes Section 129, 15 U.S.C. 1639. Section 130(a)(4), 15 U.S.C. 1640(a)(4), further authorizes recovery of amounts of type
(iii)for a failure to comply with any requirement under Section 129, 15 U.S.C. 1639, unless the creditor demonstrates that the failure to comply is not material. Under TILA Section 103(y), 15 U.S.C. 1602(y), a reference to a requirement imposed under TILA or any provision thereof also includes a reference to the regulations of the Board under TILA or the provision in question. Therefore, Section 130(a), 15 U.S.C. 1640(a), authorizes recovery from a creditor of amounts of all four types if the creditor fails to comply with a Board regulation adopted under authority of Section 129(l)(2), 15 U.S.C. 1639(l)(2). If a loan is a HOEPA loan—that is, its APR or fees exceed the triggers in § 226.32(a)—and the creditor has assigned it to another person, consumers may be able to obtain from the assignee all of the foregoing damages, including the finance charges and fees paid by the consumer. TILA Section 131(d), 15 U.S.C. 1641(d). For all other loans, TILA Section 131(e), 15 U.S.C. 1641(e), limits the liability of assignees for violations of Regulation Z to disclosure violations that are apparent on the face of the disclosure statement required by TILA. TILA does not authorize private civil actions against parties other than creditors and assignees. A creditor is the party to whom the debt is initially payable. TILA Section 103(f), 15 U.S.C. 1602(f). A mortgage broker is not a creditor unless the debt is initially payable to the broker. Loan servicers may be creditors, but often they are not. Neither is a servicer treated as an assignee under TILA if the servicer is or was the owner of the obligation only for purposes of administrative convenience in servicing the obligation. TILA Section 131(f), 15 U.S.C. 1641(f). A Consumer's Right to Rescind A consumer has a right to rescind a transaction for up to three years after consummation when the mortgage contains a provision prohibited by a rule adopted under authority of TILA Section 129(l)(2). *See* TILA Sections 125 and 129(j), 15 U.S.C. 1636 and 1639(j). Moreover, any consumer who has the right to rescind a transaction may rescind the transaction as against any assignee. TILA Section 131(c), 15 U.S.C. 1641(c). The right of rescission does not extend, however, to home purchase loans, construction loans, or certain refinancings with the same creditor. TILA Section 125(e), 15 U.S.C. 1636. Under current Regulation Z, 12 CFR 226.23(a)(3), footnote 48, a HOEPA loan having a prepayment penalty that does not conform to the requirements of § 226.32(d)(7) is a mortgage containing a provision prohibited by TILA Section 129, 15 U.S.C. 1639, and, therefore, is subject to the three-year right of the consumer to rescind. Proposed § 226.35(b)(3), which would be adopted under authority of Section 129(l)(2), 15 U.S.C. 1639(l)(2), would apply the restrictions on prepayment penalties in § 226.32(d)(6) and
(7)to higher-priced mortgage loans, as defined in proposed § 226.35(a). Accordingly, the Board is proposing to revise footnote 48 to clarify that a higher-priced mortgage loan (whether or not it is a HOEPA loan) having a prepayment penalty that does not conform to the requirements of § 226.32(d)(7), as incorporated in § 226.35(b)(3), is also subject to a three-year right of rescission. (As mentioned, however, the right of rescission does not extend to home purchase loans, construction loans, or certain refinancings with the same creditor.) Other rules the Board is proposing would not be prohibitions of particular provisions of mortgages, and violations of those rules therefore would not trigger the extended right of rescission. Advertising Rules and Civil Liability The Board's proposal in connection with advertising practices presents a unique case with respect to civil liability under TILA. TILA Section 130 provides for civil liability of creditors for violations only of chapters 2, 4, and 5 of the act, 15 U.S.C. 1640(a), whereas the advertising provisions of TILA are found in chapter 3. Accordingly, the Board's proposed rules relating to advertising disclosures, such as the disclosures about rates or payments, would not create civil liability for creditors, assignees, or other persons, because those rules would be promulgated under the Board's general rulemaking authority in TILA Section 105(a), 15 U.S.C. 1604(a). These proposed rules would, however, be subject to administrative enforcement by appropriate agencies. Proposed § 226.24(i), which would prohibit certain acts or practices in connection with closed-end advertisements for credit secured by a dwelling, would be promulgated under the Board's authority in TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). Section 130(a), 15 U.S.C. 1640(a), authorizes a civil action by any person against a creditor who fails to comply with respect to that person with a rule adopted under authority of Section 129(l)(2), 15 U.S.C. 1639(l)(2). It is not clear, however, whether a consumer may bring an action against a creditor under Section 130(a), 15 U.S.C. 1640(a), for violating an advertising restriction in proposed § 226.24(i) if the consumer has not obtained a mortgage loan from the creditor. Administrative Enforcement In addition to providing consumers remedies against creditors and assignees, the statute authorizes various agencies to enforce Regulation Z administratively against various parties. The federal banking agencies may enforce the regulation against banks and thrifts. TILA Section 108(a), 15 U.S.C. 1607(a). The Federal Trade Commission
(FTC)is generally authorized to enforce violations of Regulation Z as to any other entity or individual. TILA Section 108(c), 15 U.S.C. 1607(c). State attorneys general may enforce violations of regulations adopted under authority of TILA Section 129(l)(2). See TILA Section 130(e), 15 U.S.C. 1640(e). XIII. Effective Date Under TILA, the Board's disclosure regulations are to have an effective date of that October 1 which follows by at least six months the date of promulgation. TILA Section 105(d), 15 U.S.C. 1604(d). However, the Board may, at its discretion, lengthen the implementation period for creditors to adjust their forms to accommodate new requirements, or shorten the period where the Board makes a specific finding that such action is necessary to prevent unfair or deceptive disclosure practices. *Id.* The Board requests comment on whether six months would be an appropriate implementation period for the proposed rules. Specifically, the Board requests comment on the length of time creditors may need to implement the proposed rules, as well as on whether the Board should specify a shorter implementation period for certain provisions in order to prevent unfair or deceptive practices. XIV. Paperwork Reduction Act In accordance with the Paperwork Reduction Act
(PRA)of 1995 (44 U.S.C. 3506; 5 CFR Part 1320 Appendix A.1), the Board reviewed the proposed rule under the authority delegated to the Board by the Office of Management and Budget (OMB). The collection of information that is required by this proposed rule is found in 12 CFR part 226. The Federal Reserve may not conduct or sponsor, and an organization is not required to respond to, this information collection unless the information collection displays a currently valid OMB control number. The OMB control number is 7100-0199. This information collection is required to provide benefits for consumers and is mandatory (15 U.S.C. 1601 *et seq.* ). The respondents/recordkeepers are creditors and other entities subject to Regulation Z, including for-profit financial institutions and small businesses. TILA and Regulation Z are intended to ensure effective disclosure of the costs and terms of credit to consumers. For open-end credit, creditors are required, among other things, to disclose information about the initial costs and terms and to provide periodic statements of account activity, notices of changes in terms, and statements of rights concerning billing error procedures. Regulation Z requires specific types of disclosures for credit and charge card accounts and home-equity plans. For closed-end loans, such as mortgage and installment loans, cost disclosures are required to be provided prior to consummation. Special disclosures are required in connection with certain products, such as reverse mortgages, certain variable-rate loans, and certain mortgages with rates and fees above specified thresholds. TILA and Regulation Z also contain rules concerning credit advertising. Creditors are required to retain evidence of compliance for twenty-four months (12 CFR 226.25), but Regulation Z does not specify the types of records that must be retained. Under the PRA, the Federal Reserve accounts for the paperwork burden associated with Regulation Z for the state member banks and other creditors supervised by the Federal Reserve that engage in lending covered by Regulation Z and, therefore, are respondents under the PRA. Appendix I of Regulation Z defines the Federal Reserve-regulated institutions as: state member banks, branches and agencies of foreign banks (other than federal branches, federal agencies, and insured state branches of foreign banks), commercial lending companies owned or controlled by foreign banks, and organizations operating under section 25 or 25A of the Federal Reserve Act. Other federal agencies account for the paperwork burden on other creditors. Paperwork burden associated with entities that are not creditors will be accounted for by other federal agencies. The current total annual burden to comply with the provisions of Regulation Z is estimated to be 552,398 hours for the 1,172 Federal Reserve-regulated institutions that are deemed to be respondents for the purposes of the PRA. To ease the burden and cost of complying with Regulation Z (particularly for small entities), the Federal Reserve provides model forms, which are appended to the regulation. The proposed rule would impose a one-time increase in the total annual burden under Regulation Z for all respondents regulated by the Federal Reserve by 46,880 hours, from 552,398 to 599,278 hours. The total estimated burden increase, as well as the estimates of the burden increase associated with each major section of the proposed rule as set forth below, represents averages for all respondents regulated by the Federal Reserve. The Federal Reserve expects that the amount of time required to implement each of the proposed changes for a given institution may vary based on the size and complexity of the respondent. Furthermore, the burden estimate for this rulemaking does not include the burden addressing changes to format, timing, and content requirements for the five main types of open-end credit disclosures governed by Regulation Z as announced in a separate proposed rulemaking (Docket No. R-1286). The Federal Reserve proposes revisions to §§ 226.16 and 226.24 to require that advertisements provide accurate and balanced information, in a clear and conspicuous manner. Additional proposed revisions to § 226.24 would prohibit advertisements that are deceptive. The proposed changes to the advertising provisions would amend the open-end home-equity plan advertising rules in § 226.16 and amend the closed-end credit advertising rules in § 226.24. The two most significant changes in § 226.16 relate to the clear and conspicuous standard and the advertisement of introductory terms in home-equity plans. The three most significant changes in § 226.24 relate to strengthening the clear and conspicuous standard for advertising disclosures, regulating the disclosure of rates and payments in advertisements to ensure that low introductory or “teaser” rates or payments are not given undue emphasis, and prohibiting certain acts or practices in advertisements that the Federal Reserve finds inconsistent with the standards set forth in TILA Section 129(l)(2). The Federal Reserve estimates that 1,172 respondents regulated by the Federal Reserve would take, on average, 40 hours (one business week) to revise and update their advertising materials to comply with the proposed disclosure requirements in §§ 226.16 and 226.24. These one-time revisions would increase the burden by 46,880 hours. The other federal agencies are responsible for estimating and reporting to OMB the total paperwork burden for the institutions for which they have administrative enforcement authority. They may, but are not required to, use the Federal Reserve's burden estimates. Using the Federal Reserve's method, the total current estimated annual burden for all financial institutions subject to Regulation Z, including Federal Reserve-supervised institutions, would be approximately 61,656,695 hours. The proposed rule would increase the estimated annual burden for all institutions subject to Regulation Z by 772,000 hours to 62,428,695 hours. The above estimates represent an average across all respondents and reflect variations between institutions based on their size, complexity, and practices. All covered institutions, of which there are approximately 19,300, potentially are affected by this collection of information, and thus are respondents for purposes of the PRA. Comments are invited on:
(1)Whether the proposed collection of information is necessary for the proper performance of the Federal Reserve's functions; including whether the information has practical utility;
(2)the accuracy of the Federal Reserve's estimate of the burden of the proposed information collection, including the cost of compliance;
(3)ways to enhance the quality, utility, and clarity of the information to be collected; and
(4)ways to minimize the burden of information collection on respondents, including through the use of automated collection techniques or other forms of information technology. Comments on the collection of information should be sent to Michelle Shore, Federal Reserve Board Clearance Officer, Division of Research and Statistics, Mail Stop 151-A, Board of Governors of the Federal Reserve System, Washington, DC 20551, with copies of such comments sent to the Office of Management and Budget, Paperwork Reduction Project (7100-0199), Washington, DC 20503. XV. Initial Regulatory Flexibility Analysis In accordance with section 3(a) of the Regulatory Flexibility Act (RFA), 5 U.S.C. §§ 601-612, the Board is publishing an initial regulatory flexibility analysis for the proposed amendments to Regulation Z. The RFA requires an agency either to provide an initial regulatory flexibility analysis with a proposed rule or certify that the proposed rule will not have a significant economic impact on a substantial number of small entities. An entity is considered “small” if it has $165 million or less in assets for banks and other depository institutions; and $6.5 million or less in revenues for non-bank mortgage lenders, mortgage brokers, and loan servicers. 73 73 U.S. Small Business Administration, Table of Small Business Size Standards Matched to North American Industry Classification System Codes; available at *http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf* . Based on its analysis and for the reasons stated below, the Board believes that this proposed rule will have a significant economic impact on a substantial number of small entities. A final regulatory flexibility analysis will be conducted after consideration of comments received during the public comment period. The Board requests public comment in the following areas. Reasons for the Proposed Rule Congress enacted TILA based on findings that economic stability would be enhanced and competition among consumer credit providers would be strengthened by the informed use of credit resulting from consumers' awareness of the cost of credit. One of the stated purposes of TILA is to provide a meaningful disclosure of credit terms to enable consumers to compare credit terms available in the marketplace more readily and avoid the uninformed use of credit. TILA's disclosure requirements differ depending on whether consumer credit is an open-end (revolving) plan or a closed-end (installment) loan. TILA also contains procedural and substantive protections for consumers. TILA directs the Board to prescribe regulations to carry out the purposes of the statute. Congress enacted HOEPA in 1994 as an amendment to TILA. TILA is implemented by the Board's Regulation Z. HOEPA imposed additional substantive protections on certain high-cost mortgage transactions. HOEPA also authorized the Board to prohibit acts or practices in connection with mortgage loans that are unfair, deceptive, or designed to evade the purposes of HOEPA, and acts or practices in connection with refinancing of mortgage loans that are associated with abusive lending or are otherwise not in the interest of borrowers. The proposed regulations would prohibit certain acts or practices in connection with closed-end mortgage loans to address problems that have been observed in the mortgage market, particularly the subprime market. Some of the proposed prohibitions or restrictions would apply only to higher-priced closed-end mortgage loans secured by the consumer's principal dwelling. These include:
(1)Prohibiting a pattern or practice of extending credit based on the collateral without considering the borrower's ability to repay;
(2)requiring creditors to establish escrow accounts for taxes and insurance for first-lien loans;
(3)requiring creditors to verify income and assets they rely upon in making loans; and
(4)prohibiting prepayment penalties except under certain conditions. Other proposed prohibitions or restrictions would apply generally to closed-end mortgage loans secured by the consumer's principal dwelling. These include restrictions on certain creditor payments to brokers, a prohibition on coercion of appraisers, and a prohibition on certain mortgage loan servicing practices. Finally, the proposal would prohibit certain advertising practices in connection with closed-end mortgage loans secured by a consumer's dwelling. The Board's proposal also would require certain TILA disclosures for closed-end mortgages to be provided to the consumer earlier in the loan process. The proposal would revise the Regulation Z advertising rules to ensure that advertisements for open-end and closed-end mortgage loans provide accurate and balanced information about rates and payments. Statement of Objectives and Legal Basis The SUPPLEMENTARY INFORMATION contains this information. In summary, the proposed amendments to Regulation Z are designed to achieve three goals:
(1)Prohibit certain acts or practices for higher-priced mortgage loans secured by a consumer's principal dwelling and prohibit other acts or practices for closed-end mortgage loans secured by a consumer's principal dwelling;
(2)revise the disclosures required in advertisements for credit secured by a consumer's dwelling and prohibit certain practices in connection with closed-end mortgage advertising; and
(3)require disclosures for closed-end mortgages to be provided earlier in the transaction. The legal basis for the proposed rule is in Sections 105(a), 122(a), and 129(l)(2) of TILA. A more detailed discussion of the Board's rulemaking authority is set forth in part V of the SUPPLEMENTARY INFORMATION . Description of Small Entities to Which the Proposed Rule Would Apply The proposed regulations would apply to all institutions and entities that engage in closed-end home-secured lending and servicing. The Board is not aware of a reliable source for the total number of small entities likely to be affected by the proposal, and the credit provisions of TILA and Regulation Z have broad applicability to individuals and businesses that originate, extend and service even small numbers of home-secured credit. *See* § 226.1(c)(1). 74 All small entities that originate, extend, or service closed-end loans secured by a consumer's dwelling potentially could be subject to the proposed rule. 74 Regulation Z generally applies to “each individual or business that offers or extends credit when four conditions are met:
(i)The credit is offered or extended to consumers;
(ii)the offering or extension of credit is done regularly,
(iii)the credit is subject to a finance charge or is payable by a written agreement in more than four installments, and
(iv)the credit is primarily for personal, family, or household purposes.” § 226.1(c)(1). The Board can, however, identify through data from Reports of Condition and Income (“call reports”) approximate numbers of small depository institutions that would be subject to the proposed rules. Based on December 2006 call report data, approximately 6,932 small institutions would be subject to the proposed rule. Approximately 17,618 depository institutions in the United States filed call report data, approximately 13,018 of which had total domestic assets of $165 million or less and thus were considered small entities for purposes of the Regulatory Flexibility Act. Of 4,558 banks, 615 thrifts and 7,691 credit unions that filed call report data and were considered small entities, 4,389 banks, 574 thrifts, and 5,104 credit unions, totaling 10,067 institutions, extended mortgage credit. For purposes of this analysis, thrifts include savings banks, savings and loan entities, co-operative banks and industrial banks. Filed call report data Filed call report data and had assets <= $165M Filed call report data and originated or extended mortgage credit Filed call report data and originated or extended mortgage credit with assets <= $165M Filed call report data and originated or extended mortgage credit with assets <= $165M and did not file HMDA Commercial banks 7,423 4,558 7,210 4,389 2,808 Thrifts 75 1,344 615 1,280 574 254 Credit unions 8,535 7,691 5,948 5,104 3,870 Other 316 154 0 0 0 Total 17,618 13,018 14,438 10,067 6,932 The Board cannot identify with certainty the number of small non-depository institutions that would be subject to the proposed rule. Home Mortgage Disclosure Act
(HMDA)76 data indicate that 2,004 non-depository institutions filed HMDA reports in 2006. 77 Based on the small volume of lending activity reported by these institutions, most are likely to be small. 75 Thrifts include savings banks, savings and loan associations, co-operative and industrial banks. 76 The 8,886 lenders (both depository institutions and mortgage companies) covered by HMDA in 2006 accounted for an estimated 80% of all home lending in the United States. Under HMDA, lenders use a ”loan/application register” (HMDA/LAR) to report information annually to their federal supervisory agencies for each application and loan acted on during the calendar year. Lenders must make their HMDA/LARs available to the public by March 31 following the year to which the data relate, and they must remove the two date-related fields to help preserve applicants' privacy. Only lenders that have offices (or, for non-depository institutions, are deemed to have offices) in metropolitan areas are required to report under HMDA. However, if a lender is required to report, it must report information on all of its home loan applications and loans in all locations, including non-metropolitan areas. 77 The 2006 HMDA Data, *http://www.federalreserve.gov/pubs/bulletin/2007/pdf/hmda06draft.pdf.* Certain parts of the proposal would apply to mortgage brokers and mortgage servicers. According to the National Association of Mortgage Brokers, in 2004 there were 53,000 mortgage brokerage companies that employed an estimated 418,700 people. 78 The Board believes that most of these companies are small entities. 79 78 *http://www.namb.org/namb/Industry_Facts.asp?SnID=719224934* 79 In the first quarter of 2007, 77% of brokers (NAICS 522310) had fewer than five employees; only 0.4% had 100 or more employees, thus it seems likely that most have revenues below the threshold. (Bureau of Labor Statistics' Quarterly Census of Employment and Wages). The proposal would prohibit certain unfair mortgage servicing practices. The Board is not aware, however, of a source of data for the number of small mortgage servicers. The available data are not sufficient for the Board to realistically estimate the number of mortgage servicers that would be subject to the proposed rule and that are small as defined by the Small Business Administration. The Board invites comment and information on the number and type of small entities affected by the proposed rule. Projected Reporting, Recordkeeping, and Other Compliance Requirements The compliance requirements of the proposed rules are described in parts VI through VIII and in parts X and XI of the SUPPLEMENTARY INFORMATION . The effect of the proposed revisions to Regulation Z on small entities is unknown. Some small entities would be required, among other things, to modify their underwriting practices and home-secured credit disclosures to comply with the revised rules. The precise costs to small entities of updating their systems, disclosures, and underwriting practices are difficult to predict. These costs will depend on a number of unknown factors, including, among other things, the specifications of the current systems used by such entities to prepare and provide disclosures and/or solicitations and to administer and maintain accounts, the complexity of the terms of credit products that they offer, and the range of such product offerings. Additionally, the proposed rules could affect how mortgage brokers are compensated. The precise costs that the proposed rule would impose on mortgage brokers are also difficult to ascertain. Nevertheless, the Board believes that these costs will have a significant economic effect on small entities, including mortgage brokers. The Board seeks information and comment on any costs, compliance requirements, or changes in operating procedures arising from the application of the proposed rule to small institutions. Identification of Duplicative, Overlapping, or Conflicting Federal Rules *Other federal rules.* The Board has not identified any federal rules that conflict with the proposed revisions to Regulation Z. *Overlap with RESPA.* Certain terms defined in the proposed rule, such as “escrow account,” “servicer” and “servicing,” cross-reference existing definitions under the U.S. Department of Housing and Urban Development's
(HUD)Regulation X (Real Estate Settlement Procedures Act (RESPA). *Overlap with HUD's guidance.* The Board recognizes that HUD has issued policy statements regarding creditor payments to mortgage brokers under RESPA and guidance as to disclosure of such payments on the Good Faith Estimate and HUD-1 Settlement Statement. The Board is also aware that HUD has announced its intention to propose improved disclosures for broker compensation under RESPA in the near future. The Board intends that its proposal would complement any proposal by HUD. The proposed provision regarding creditor payments to brokers is intended to be consistent with HUD's existing guidance regarding broker compensation under Section 8 of RESPA. Identification of Duplicative, Overlapping, or Conflicting State Laws Certain sections of the proposed rules may result in inconsistency with certain state laws. *Escrows.* Certain states have laws regulating escrows for taxes and insurance. Section 226.35(b)(4) would require creditors to establish escrow accounts for taxes and insurance for first-lien higher-priced loans, but allow creditors to allow borrowers to opt out of escrows 12 months after loan consummation. These provisions may be inconsistent with certain state laws that limit creditors' ability to require escrows or provide consumers with a right to opt out of an escrow sooner than 12 months after loan consummation. *Creditor payments to brokers.* The Board is aware that many states regulate brokers and their compensation in various respects. Under TILA Section 111, the proposed rule would not preempt such state laws except to the extent they are inconsistent with the proposal's requirements. 15 U.S.C. 1610. The Board seeks comment regarding any state or local statutes or regulations, that would duplicate, overlap, or conflict with the proposed rule. Discussion of Significant Alternatives The Board considered whether improved disclosures could protect consumers against unfair acts or practices in connection with closed-end mortgage loans secured by a consumer's principal dwelling as well as the proposed rule. While the Board anticipates proposing improvements to mortgage loan disclosures, it does not appear that better disclosures alone will address unfair, abusive, or deceptive practices in the mortgage market, including the subprime market. The Board welcomes comments on any significant alternatives, consistent with the requirements of TILA, that would minimize the impact of the proposed rule on small entities. List of Subjects in 12 CFR Part 226 Advertising, Consumer protection, Federal Reserve System, Mortgages, Reporting and recordkeeping requirements, Truth in lending. Text of Proposed Revisions Certain conventions have been used to highlight the proposed revisions. New language is shown inside bold arrows, and language that would be deleted is set off with bold brackets. Authority and Issuance For the reasons set forth in the preamble, the Board proposes to amend Regulation Z, 12 CFR part 226, as set forth below: PART 226—TRUTH IN LENDING (REGULATION Z) 1. The authority citation for part 226 is amended to read as follows: Authority: 12 U.S.C. 3806; 15 U.S.C. 1604▸,◂ [ and ] 1637(c)(5)▸, and 1639(l)◂. Subpart A—General 2. Section 226.1 is amended by revising paragraph (d)(5) to read as follows: § 226.1 Authority, purpose, coverage, organization, enforcement and liability.
(d)* * *
(5)Subpart E contains special rules for mortgage transactions. Section 226.32 requires certain disclosures and provides limitations for loans that have rates and fees above specified amounts. Section 226.33 requires disclosures, including the total annual loan cost rate, for reverse mortgage transactions. Section 226.34 prohibits specific acts and practices in connection with mortgage transactions ▸ that are subject to § 226.32. Section 226.35 prohibits specific acts and practices in connection with higher-priced mortgage loans, as defined in § 226.35(a). Section 226.36 prohibits specific acts and practices in connection with credit secured by a consumer's principal dwelling◂. Subpart B—Open-End Credit 3. Section 226.16 is amended by revising paragraphs (d)(1) through (d)(4), removing and reserving footnote 36e, and adding new paragraphs (d)(6) and
(f)to read as follows: § 226.16 Advertising.
(d)*Additional requirements for home-equity plans* —(1) *Advertisement of terms that require additional disclosures.* If any of the terms required to be disclosed under § ▸226.6(a)(1) or (2)◂ [ 226.6(a) or
(b)] or the payment terms of the plan are set forth, affirmatively or negatively, in an advertisement for a home-equity plan subject to the requirements of § 226.5b, the advertisement also shall clearly and conspicuously set forth the following:
(i)Any loan fee that is a percentage of the credit limit under the plan and an estimate of any other fees imposed for opening the plan, stated as a single dollar amount or a reasonable range.
(ii)Any periodic rate used to compute the finance charge, expressed as an annual percentage rate as determined under § 226.14(b).
(iii)The maximum annual percentage rate that may be imposed in a variable-rate plan.
(2)*Discounted and premium rates.* If an advertisement states an initial annual percentage rate that is not based on the index and margin used to make later rate adjustments in a variable-rate plan, the advertisement also shall state ▸with equal prominence and in close proximity to the initial rate:
(i)T◂ [ t ] he period of time such ▸initial◂ rate will be in effect▸;◂ and [ , with equal prominence to the initial rate, ] ▸(ii) A◂ [ a ] reasonably current annual percentage rate that would have been in effect using the index and margin.
(3)*Balloon payment* . If an advertisement contains a statement [ about ] ▸of◂ any minimum periodic payment ▸and a balloon payment may result if only the minimum periodic payments are made, even if such a payment is uncertain or unlikely◂, the advertisement also shall state [ , if applicable, ] ▸with equal prominence and in close proximity to the minimum periodic payment statement◂ that a balloon payment may result▸, if applicable◂. 36e ▸A balloon payment results if paying the minimum periodic payments does not fully amortize the outstanding balance by a specified date or time, and the consumer is required to repay the entire outstanding balance at such time. If a balloon payment will occur when the consumer makes only the minimum payments required under the plan, an advertisement for such a program which contains any statement of any minimum periodic payment shall also state with equal prominence and in close proximity to the minimum periodic payment statement: 36e ▸ [ Reserved. ] ◂ [ See footnote 10b. ]
(i)That a balloon payment will result; and
(ii)The amount and timing of the balloon payment that will result if the consumer makes only the minimum payments for the maximum period of time that the consumer is permitted to make such payments.◂
(4)*Tax implications.* An advertisement that states that any interest expense incurred under the home-equity plan is or may be tax deductible may not be misleading in this regard. ▸If an advertisement distributed in paper form or through the Internet (rather than by radio or television) is for a home-equity plan secured by the consumer's principal dwelling, and the advertised extension of credit may, by its terms, exceed the fair market value of the dwelling, the advertisement shall clearly and conspicuously state that:
(i)The interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible for Federal income tax purposes; and
(ii)The consumer should consult a tax adviser for further information regarding the deductibility of interest and charges.◂ ▸(6) *Introductory rates and payments* .
(i)*Definitions.* The following definitions apply for purposes if paragraph (d)(6) of this section.
(A)*Introductory rate.* The term “introductory rate” means, in a variable-rate plan, any annual percentage rate that is not based on the index and margin that will be used to make rate adjustments under the plan, if that rate is less than a reasonably current annual percentage rate that would be in effect under the index and margin that will be used to make rate adjustments under the plan.
(B)*Introductory payment.* The term “introductory payment” means— ( *1* ) For a variable-rate plan, any payment applicable for an introductory period that: ( *i* ) Is not derived by applying the index and margin to the outstanding balance when such index and margin will be used to determine other payments under the plan; and ( *ii* ) Is less than other payments under the plan derived by applying a reasonably current index and margin that will be used to determine the amount of such payments, given an assumed balance. ( *2* ) For a plan other than a variable-rate plan, any payment applicable for an introductory period if that payment is less than other payments that will be in effect under the plan given an assumed balance.
(C)*Introductory period.* An “introductory period” means a period of time, less than the full term of the loan, that the introductory rate or introductory payment may be applicable.
(ii)*Stating the term “introductory”* . If any annual percentage rate is an introductory rate, or if any payment is an introductory payment, the term “ *introductory* ” or “ *intro* ” must be stated in immediate proximity to each listing of the introductory rate or payment.
(iii)*Stating the introductory period and post-introductory rate or payments* . If any annual percentage rate that may be applied to a plan is an introductory rate, or if any payment applicable to a plan is an introductory payment, the following must be disclosed in a clear and conspicuous manner with equal prominence and in close proximity to each listing of the introductory rate or payment:
(A)The period of time during which the introductory rate or introductory payment will apply;
(B)In the case of an introductory rate, any annual percentage rate that will apply under the plan. If such rate is variable, the annual percentage rate must be disclosed in accordance with the accuracy standards in §§ 226.5b, or 226.16(b)(1)(ii) as applicable; and
(C)In the case of an introductory payment, the amounts and time periods of any payments that will apply under the plan. In variable-rate transactions, payments that will be determined based on application of an index and margin shall be disclosed based on a reasonably current index and margin.
(iv)*Envelope excluded* . The requirements in paragraph (d)(6)(iii) of this section do not apply to an envelope in which an application or solicitation is mailed, or to a banner advertisement or pop-up advertisement linked to an application or solicitation provided electronically.◂ ▸(f) *Alternative disclosures—television or radio advertisements* . An advertisement made through television or radio stating any of the terms requiring additional disclosures under paragraph (b)(1) or (d)(1) of this section may alternatively comply with paragraph (b)(1) or (d)(1) of this section by stating the information required by paragraph (b)(1)(ii) of this section or paragraph (d)(1)(ii) of this section, as applicable, and listing a toll-free telephone number along with a reference that such number may be used by consumers to obtain additional cost information.◂ Subpart C—Closed-End Credit 4. Section 226.17 is amended by revising paragraph
(b)and the introductory text of paragraph (f), and removing and reserving footnote 39 to read as follows: § 226.17 General disclosure requirements.
(b)*Time of disclosures.* The creditor shall make disclosures before consummation of the transaction. In certain [ residential ] mortgage transactions, special timing requirements are set forth in § 226.19(a). In certain variable-rate transactions, special timing requirements for variable-rate disclosures are set forth in § 226.19(b) and § 226.20(c). In certain transactions involving mail or telephone orders or a series of sales, the timing of the disclosures may be delayed in accordance with paragraphs
(g)and
(h)of this section.
(f)*Early disclosures.* If disclosures required by this subpart are given before the date of consummation of a transaction and a subsequent event makes them inaccurate, the creditor shall disclose before consummation ▸(except that, for certain mortgage transactions, § 226.19(a)(2) permits redisclosure no later than consummation or settlement, whichever is later).◂ 39 — 39 ▸ [ Reserved. ] ◂ [ For certain residential mortgage transactions, section 226.19(a)(2) permits redisclosure no later than consummation or settlement, whichever is later. ] 5. Section 226.19 is amended by revising the heading and paragraph (a)(1) to read as follows: § 226.19 Certain [ residential ] mortgage and variable-rate transactions.
(a)[ *Residential m* ] ▸M◂ *ortgage transactions subject to RESPA* —(1)▸(i)◂ *Time of disclosures.* In a [ residential ] mortgage transaction subject to the Real Estate Settlement Procedures Act (12 U.S.C. 2601 et seq.) ▸that is secured by the consumer's principal dwelling, other than a home equity line of credit subject to § 226.5b,◂ the creditor shall make good faith estimates of the disclosures required by § 226.18 before consummation, or shall deliver or place them in the mail not later than three business days after the creditor receives the consumer's written application, whichever is earlier. ▸(ii) *Imposition of fees.* Except as provided in paragraph (a)(1)(iii) of this section, neither a creditor nor any other person may impose a fee on the consumer in connection with the consumer's application for a mortgage transaction subject to paragraph (a)(1)(i) of this section before the consumer has received the disclosures required by paragraph (a)(1)(i) of this section. If the disclosures are mailed to the consumer, the consumer is considered to have received them three business days after they are mailed.
(iii)*Exception to fee restriction.* A creditor or other person may impose a fee for obtaining the consumer's credit report before the consumer has received the disclosure required by paragraph (a)(1)(i) of this section, provided the fee is *bona fide* and reasonable in amount.◂ 6. Section 226.24 is revised to read as follows: § 226.24 Advertising.
(a)*Actually available terms.* If an advertisement for credit states specific credit terms, it shall state only those terms that actually are or will be arranged or offered by the creditor. ▸(b) *Clear and conspicuous standard.* Disclosures required by this section shall be made clearly and conspicuously.◂ ▸(c)◂ [
(b)] *Advertisement of rate of finance charge.* If an advertisement states a rate of finance charge, it shall state the rate as an “annual percentage rate,” using that term. If the annual percentage rate may be increased after consummation, the advertisement shall state that fact.▸ If an advertisement is for credit not secured by a dwelling, t◂ [ T ] he advertisement shall not state any other rate, except that a simple annual rate or periodic rate that is applied to an unpaid balance may be stated in conjunction with, but not more conspicuously than, the annual percentage rate.▸ If an advertisement is for credit secured by a dwelling, the advertisement shall not state any other rate, except that a simple annual rate that is applied to an unpaid balance may be stated in conjunction with, but not more conspicuously than, the annual percentage rate.◂ ▸(d)◂ [
(c)] *Advertisement of terms that require additional disclosures* —(1) ▸ *Triggering terms.* ◂ If any of the following terms is set forth in an advertisement, the advertisement shall meet the requirements of paragraph ▸(d)◂ [
(c)]
(2)of this section:
(i)The amount or percentage of any downpayment.
(ii)The number of payments or period of repayment.
(iii)The amount of any payment.
(iv)The amount of any finance charge.
(2)▸ *Additional terms.* ◂ An advertisement stating any of the terms in paragraph ▸(d)◂ [
(c)]
(1)of this section shall state the following terms, 49 as applicable (an example of one or more typical extensions of credit with a statement of all the terms applicable to each may be used): 49 ▸ [ Reserved. ] ◂ [ An example of one or more typical extensions of credit with a statement of all the terms applicable to each may be used. ]
(i)The amount or percentage of the downpayment.
(ii)The terms of repayment ▸, which reflect the repayment obligations over the full term of the loan, including any balloon payment◂.
(iii)The “annual percentage rate,” using that term, and, if the rate may be increased after consummation, that fact. ▸(e)◂ [
(d)] *Catalogs or other multiple-page advertisements; electronic advertisements* .
(1)If a catalog or other multiple-page advertisement, or an electronic advertisement (such as an advertisement appearing on an Internet Web site), gives information in a table or schedule in sufficient detail to permit determination of the disclosures required by paragraph ▸(d)◂ [
(c)]
(2)of this section, it shall be considered a single advertisement if—
(i)The table or schedule is clearly and conspicuously set forth; and
(ii)Any statement of the credit terms in paragraph ▸(d)◂ [
(c)]
(1)of this section appearing anywhere else in the catalog or advertisement clearly refers to the page or location where the table or schedule begins.
(2)A catalog or other multiple-page advertisement or an electronic advertisement (such as an advertisement appearing on an Internet Web site) complies with paragraph ▸(d)◂ [
(c)]
(2)of this section if the table or schedule of terms includes all appropriate disclosures for a representative scale of amounts up to the level of the more commonly sold higher-priced property or services offered. ▸(f) *Disclosure of Rates and Payments in Advertisements for Credit Secured by a Dwelling.*
(1)*Scope.* The requirements of this paragraph apply to any advertisement for credit secured by a dwelling, other than television or radio advertisements, including promotional materials accompanying applications.
(2)*Disclosure of rates* —(i) *In general.* If an advertisement for credit secured by a dwelling states a simple annual rate of interest and more than one simple annual rate of interest will apply over the term of the advertised loan, the advertisement shall disclose in a clear and conspicuous manner:
(A)Each simple annual rate of interest that will apply. In variable-rate transactions, a rate determined by adding an index and margin shall be disclosed based on a reasonably current index and margin;
(B)The period of time during which each simple annual rate of interest will apply; and
(C)The annual percentage rate for the loan. If such rate is variable, the annual percentage rate shall comply with the accuracy standards in §§ 226.17(c) and 226.22.
(ii)*Clear and conspicuous requirement.* For purposes of paragraph (f)(2)(i) of this section, clearly and conspicuously disclosed means that the required information in paragraphs (f)(2)(i)(A) through
(C)shall be disclosed with equal prominence and in close proximity to any advertised rate that triggered the required disclosures. The required information in paragraph (f)(2)(i)(C) may be disclosed with greater prominence than the other information.
(3)*Disclosure of payments* —(i) *In general.* In addition to the requirements of paragraph
(c)of this section, if an advertisement for credit secured by a dwelling states the amount of any payment, the advertisement shall disclose in a clear and conspicuous manner:
(A)The amount of each payment that will apply over the term of the loan, including any balloon payment. In variable-rate transactions, payments that will be determined based on the application of the sum of an index and margin shall be disclosed based on a reasonably current index and margin;
(B)The period of time during which each payment will apply; and
(C)In an advertisement for credit secured by a first lien on a dwelling, the fact that the payments do not include amounts for taxes and insurance premiums, if applicable, and that the actual payment obligation will be greater.
(ii)*Clear and conspicuous requirement.* For purposes of paragraph (f)(3)(i) of this section, a clear and conspicuous disclosure means that the required information in paragraphs (f)(3)(i)(A) and
(B)shall be disclosed with equal prominence and in close proximity to any advertised payment that triggered the required disclosures, and that the required information in paragraph (f)(3)(i)(C) shall be disclosed with prominence and in close proximity to the advertised payments.
(4)*Envelope excluded.* The requirements in paragraphs (f)(2) and (f)(3) of this section do not apply to an envelope in which an application or solicitation is mailed, or to a banner advertisement or pop-up advertisement linked to an application or solicitation provided electronically.
(g)*Alternative disclosures—television or radio advertisements.* An advertisement made through television or radio stating orally any of the terms requiring additional disclosures under paragraph (d)(2) of this section may comply with paragraph (d)(2) of this section either by:
(1)Stating orally each of the additional disclosures required under paragraph (d)(2) of this section at a speed and volume sufficient for a consumer to hear and comprehend them; or
(2)Stating orally the information required by paragraph (d)(2)(iii) of this section at a speed and volume sufficient for a consumer to hear and comprehend them, and listing a toll-free telephone number along with a reference that such number may be used by consumers to obtain additional cost information.
(h)*Tax implications.* If an advertisement distributed in paper form or through the Internet (rather than by radio or television) is for a loan secured by the consumer's principal dwelling, and the advertised extension of credit may, by its terms, exceed the fair market value of the dwelling, the advertisement shall clearly and conspicuously state that:
(1)The interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible for Federal income tax purposes; and
(2)The consumer should consult a tax adviser for further information regarding the deductibility of interest and charges.
(i)*Prohibited acts or practices in advertisements for credit secured by a dwelling.* The following acts or practices are prohibited in advertisements for credit secured by a dwelling:
(1)*Misleading advertising of “fixed” rates and payments.* Using the word “fixed” to refer to rates, payments, or the credit transaction in an advertisement for variable-rate transactions or other transactions where the advertised payment may increase, unless:
(i)In the case of an advertisement solely for one or more variable-rate transactions,
(A)The phrase “Adjustable-Rate Mortgage” or “Variable-Rate Mortgage” appears in the advertisement before the first use of the word “fixed” and is at least as conspicuous as every use of the word “fixed” in the advertisement; and
(B)Each use of the word “fixed” to refer to a rate or payment is accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed, and the fact that the rate may vary or the payment may increase after that period;
(ii)In the case of an advertisement solely for transactions other than variable-rate transactions where the advertised payment may increase ( *e.g.* , a fixed-rate mortgage transaction with an initial lower payment), each use of the word “fixed” to refer to the advertised payment is accompanied by an equally prominent and closely proximate statement of the time period for which the payment is fixed, and the fact that the payment may increase after that period; or
(iii)In the case of an advertisement for both variable-rate transactions and non-variable-rate transactions,
(A)The phrase “Adjustable-Rate Mortgage,” “Variable-Rate Mortgage,” or “ARM” appears in the advertisement with equal prominence as any use of the term “fixed,” “Fixed-Rate Mortgage,” or similar terms; and
(B)Each use of the word “fixed” to refer to a rate, payment, or the credit transaction either refers solely to the transactions for which rates are fixed and complies with paragraph (i)(1)(ii) of this section, if applicable, or, if it refers to the variable-rate transactions, is accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed, and the fact that the rate may vary or the payment may increase after that period.
(2)*Misleading comparisons in advertisements.* Making any comparison in an advertisement between an actual or hypothetical consumer's current credit payments or rates and any payment or simple annual rate that will be available under the advertised product for less than the term of the loan, unless:
(i)*In general.* The advertisement includes:
(A)An equally prominent, closely proximate comparison to all applicable payments or rates for the advertised product that will apply over the term of the loan and an equally prominent, closely proximate statement of the period of time for which each applicable payment or rate applies; and
(B)A prominent statement in close proximity to the payments described in paragraph (i)(2)(i)(A) of this section that the advertised payments do not include amounts for taxes and insurance premiums, if applicable; or
(ii)*Application to variable-rate transactions.* If the advertisement is for a variable-rate transaction, and the advertised payment or simple annual rate is based on the index and margin that will be used to make subsequent rate or payment adjustments over the term of the loan, the advertisement includes:
(A)An equally prominent statement in close proximity to the payment or rate that the payment or rate is subject to adjustment and the time period when the first adjustment will occur; and
(B)A prominent statement in close proximity to the advertised payment that the payment does not include amounts for taxes and insurance premiums, if applicable.
(3)*Misrepresentations about government endorsement.* Making any statement in an advertisement that the product offered is a “government loan program”, “government-supported loan”, or is otherwise endorsed or sponsored by any federal, state, or local government entity, unless the advertisement is for an FHA loan, VA loan, or similar loan program that is, in fact, endorsed or sponsored by a federal, state, or local government entity.
(4)*Misleading use of the current lender's name.* Using the name of the consumer's current lender in an advertisement that is not sent by or on behalf of the consumer's current lender, unless the advertisement:
(i)Discloses with equal prominence the name of the person or creditor making the advertisement; and
(ii)Includes a clear and conspicuous statement that the person making the advertisement is not associated with, or acting on behalf of, the consumer's current lender.
(5)*Misleading claims of debt elimination.* Making any claim in an advertisement that the mortgage product offered will eliminate debt or result in a waiver or forgiveness of a consumer's existing loan terms with, or obligations to, another creditor.
(6)*Misleading claims suggesting a fiduciary or other relationship.* Using the terms “counselor” or “financial advisor” in an advertisement to refer to a for-profit mortgage broker or mortgage lender, its employees, or persons working for the broker or lender that are involved in offering, originating or selling mortgages.
(7)*Misleading foreign-language advertisements.* Providing information about some trigger terms or required disclosures, such as an initial rate or payment, only in a foreign language in an advertisement, but providing information about other trigger terms or required disclosures, such as information about the fully-indexed rate or fully amortizing payment, only in English in the same advertisement.◂ Subpart E—Special Rules for Certain Home Mortgage Transactions 7. Section 226.32 is amended by revising paragraph (d)(7) to read as follows: § 226.32 Requirements for certain closed-end home mortgages.
(d)* * *
(7)*Prepayment penalty exception.* A mortgage transaction subject to this section may provide for a prepayment penalty otherwise permitted by law (including a refund calculated according to the rule of 78s) if:
(i)The penalty can be exercised only for the first five years following consummation;
(ii)The source of the prepayment funds is not a refinancing by the creditor or an affiliate of the creditor; [ and ]
(iii)At consummation, the consumer's total monthly ▸debt payments◂ [ debts ] (including amounts owed under the mortgage) do not exceed 50 percent of the consumer's monthly gross income, as verified ▸in accordance with § 226.35(b)(2)(i); and◂ [ by the consumer's signed financial statement, a credit report, and payment records for employment income. ] ▸(iv) The penalty period ends at least sixty days prior to the first date, if any, on which the principal or interest payment amount may increase under the terms of the loan.◂ 8. Section 226.34 is amended by revising the heading and paragraph (a)(4) to read as follows: § 226.34 Prohibited acts or practices in connection with credit [ secured by a consumer's dwelling ] ▸subject to § 226.32◂.
(a)* * * [
(4)*Repayment ability.* Engage in a pattern or practice of extending credit subject to § 226.32 to a consumer based on the consumer's collateral without regard to the consumer's repayment ability, including the consumer's current income, current obligations, and employment. There is a presumption that a creditor has violated this paragraph (a)(4) if the creditor engages in a pattern or practice of making loans subject to§ 226.32 without verifying and documenting consumers' repayment ability. ] ▸(4) *Repayment ability.* Engage in a pattern or practice of extending credit subject to § 226.32 to consumers based on the value of consumers' collateral without regard to consumers' repayment ability as of consummation, including consumers' current and reasonably expected income, current and reasonably expected obligations, employment, and assets other than the collateral.
(i)There is a presumption that a creditor has violated this paragraph (a)(4) if the creditor engages in a pattern or practice of failing to—
(A)Verify and document consumers' repayment ability in accordance with § 226.35(b)(2)(i);
(B)Consider consumers' ability to make loan payments based on the interest rate, determined as follows in the case of a loan in which the interest rate may increase after consummation— ( *1* ) For a variable rate loan, the interest rate as determined by adding the margin and the index value as of consummation, or the initial rate if that rate is greater than the sum of the index value and margin as of consummation; and ( *2* ) For a step-rate loan, the highest interest rate possible within the first seven years of the loan's term;
(C)Consider consumers' ability to make loan payments based on a fully-amortizing payment that includes, as applicable: expected property taxes; homeowners' association dues; premiums for insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property; premiums for any guarantee or insurance protecting the creditor against consumers' default or other credit loss; and premiums for other mortgage related insurance;
(D)Consider the ratio of consumers' total debt obligations to consumers' income; or
(E)Consider the income consumers will have after paying debt obligations.
(ii)A creditor does not violate this paragraph (a)(4) if it has a reasonable basis to believe consumers will be able to make loan payments for at least seven years after consummation of the transaction, considering the factors identified in paragraph (a)(4)(i) of this section and any other factors relevant to determining repayment ability.
(iii)This paragraph (a)(4) does not apply to temporary or “bridge” loans with terms of twelve months or less, such as a loan to purchase a new dwelling where the consumer plans to sell a current dwelling within twelve months.◂ 9. New § 226.35 is added to read as follows: ▸§ 226.35 Prohibited acts or practices in connection with higher-priced mortgage loans.
(a)*Higher-priced mortgage loans.*
(1)For purposes of this section, a higher-priced mortgage loan is a consumer credit transaction that is secured by the consumer's principal dwelling in which the annual percentage rate at consummation will exceed the yield on comparable Treasury securities by three or more percentage points for loans secured by a first lien on a dwelling, or by five or more percentage points for loans secured by a subordinate lien on a dwelling.
(2)Comparable Treasury securities are determined as follows for variable rate loans:
(i)For a loan with an initial rate that is fixed for more than one year, securities with a maturity matching the duration of the fixed-rate period, unless the fixed-rate period exceeds seven years, in which case the creditor should use the rules applied to non-variable rate loans; and
(ii)For all other loans, securities with a maturity of one year.
(3)Comparable Treasury securities are determined as follows for non-variable rate loans:
(i)For a loan with a term of twenty years or more, securities with a maturity of ten years;
(ii)For a loan with a term of more than seven years but less than twenty years, securities with a maturity of seven years; and
(iii)For a loan with a term of seven years or less, securities with a maturity matching the term of the transaction.
(4)The creditor shall use the yield on Treasury securities as of the 15th day of the preceding month if the creditor receives the application between the 1st and the 14th day of the month and as of the 15th day of the current month if the creditor receives the application on or after the 15th day.
(5)Notwithstanding paragraph (a)(1) of this section, a higher-priced mortgage loan excludes a transaction to finance the initial construction of a dwelling, a temporary or “bridge” loan with a term of twelve months or less, such as a loan to purchase a new dwelling where the consumer plans to sell a current dwelling within twelve months, a reverse-mortgage transaction subject to § 226.33, or a home equity line of credit subject to § 226.5b.
(b)*Rules for higher-priced mortgage loans.* Higher-priced mortgage loans are subject to the following restrictions:
(1)*Repayment ability.* A creditor shall not engage in a pattern or practice of extending credit as provided in § 226.34(a)(4).
(2)*Verification of income and assets relied on.*
(i)A creditor shall not rely on amounts of income, including expected income, or assets in approving an extension of credit unless the creditor verifies such amounts by the consumer's Internal Revenue Service Form W-2, tax returns, payroll receipts, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer's income or assets.
(ii)A creditor has not violated paragraph (b)(2)(i) of this section if the amounts of income and assets that the creditor relied upon in approving the transaction are not materially greater than the amounts of the consumer's income or assets that the creditor could have verified pursuant to paragraph (b)(2)(i) of this section at the time the loan was consummated.
(3)*Prepayment penalties.* A loan shall not include a prepayment penalty provision except under the conditions provided in § 226.32(d)(7).
(4)*Failure to escrow for property taxes and insurance.* Prior to or at consummation of a loan secured by a first lien on a dwelling, an escrow account must be established for payment of property taxes; premiums for insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property; premiums for any guarantee or insurance protecting the creditor against the consumer's default or other credit loss; and premiums for other mortgage-related insurance.
(i)A creditor may permit a consumer to cancel the escrow account required in paragraph (b)(4) only in response to a consumer's dated written request to cancel the escrow account that is received no earlier than twelve months after consummation.
(ii)For purposes of this section, “escrow account” shall have the same meaning as in 24 CFR 3500.17(b) as amended.
(5)*Evasion; open-end credit.* In connection with credit secured by a consumer's principal dwelling that does not meet the definition of open-end credit in § 226.2(a)(20), a creditor shall not structure a home-secured loan as an open-end plan to evade the requirements of this section.◂ 10. New § 226.36 is added to read as follows: ▸§ 226.36 Prohibited acts or practices in connection with credit secured by a consumer's principal dwelling.
(a)*Creditor payments to mortgage brokers.*
(1)In connection with a consumer credit transaction secured by a consumer's principal dwelling, except as provided in paragraph (a)(2) of this section, a creditor shall not make any payment, directly or indirectly, to a mortgage broker unless the broker enters into a written agreement with the consumer that satisfies the conditions set forth in this paragraph (a)(1). A creditor payment to a mortgage broker subject to this paragraph (a)(1) shall not exceed the total compensation amount stated in the written agreement, reduced by any amounts paid directly by the consumer or by any other source. The written agreement must be entered into before the consumer pays a fee to any person in connection with the mortgage transaction or submits a written application to the broker for the transaction, whichever is earlier. The written agreement must include a clear and conspicuous statement—
(i)Of the total amount of compensation the mortgage broker will receive and retain from all sources, as a dollar amount;
(ii)That the consumer will pay the entire amount of compensation that the mortgage broker will receive and retain, even if all or part is paid directly by the creditor, because the creditor recovers such payments through a higher interest rate; and
(iii)That creditor payments to a mortgage broker can influence the broker to offer certain loan products or terms to the consumer that are not in the consumer's interest or are not the most favorable the consumer otherwise could obtain.
(2)Paragraph (a)(1) of this section does not apply to a transaction—
(i)That is subject to a state statute or regulation that expressly imposes a duty on mortgage brokers, under which a mortgage broker may not offer to consumers loan products or terms that are not in consumers' interest or are less favorable than consumers otherwise could obtain, and that requires that a mortgage broker provide consumers with a written agreement that includes a description of the mortgage broker's role in the transaction and the mortgage broker's relationship to the consumer, as defined by such statute or regulation; or
(ii)Where the creditor can demonstrate that the compensation it pays to a mortgage broker in connection with a transaction is not determined, in whole or in part, by reference to the transaction's interest rate.
(b)*Misrepresentation of value of consumer's dwelling* —(1) *Coercion of appraiser.* In connection with a consumer credit transaction secured by a consumer's principal dwelling, no creditor or mortgage broker, and no affiliate of a creditor or mortgage broker shall directly or indirectly coerce, influence, or otherwise encourage an appraiser to misstate or misrepresent the value of such dwelling.
(i)Examples of actions that violate paragraph (b)(1) of this section include:
(A)Implying to an appraiser that current or future retention of the appraiser depends on the amount at which the appraiser values a consumer's principal dwelling;
(B)Failing to compensate an appraiser because the appraiser does not value a consumer's principal dwelling at or above a certain amount; and
(C)Conditioning an appraiser's compensation on loan consummation.
(ii)Examples of actions that do not violate this subsection include:
(A)Asking an appraiser to consider additional information about a consumer's principal dwelling or about comparable properties;
(B)Requesting that an appraiser provide additional information about the basis for a valuation;
(C)Requesting that an appraiser correct factual errors in a valuation;
(D)Obtaining multiple appraisals of a consumer's principal dwelling, so long as the creditor adheres to a policy of selecting the most reliable appraisal, rather than the appraisal that states the highest value;
(E)Withholding compensation from an appraiser for breach of contract or substandard performance of services as provided by contract;
(F)Terminating a relationship with an appraiser for violations of applicable federal or state law or breaches of ethical or professional standards; and
(G)Taking action permitted or required by applicable federal or state statute, regulation, or agency guidance.
(2)*When extension of credit prohibited.* In connection with a consumer credit transaction secured by a consumer's principal dwelling, a creditor who knows or has reason to know, at or before loan consummation, of a violation of § 226.36(b)(1) in connection with an appraisal shall not extend credit based on such appraisal unless the creditor documents that it has acted with reasonable diligence to determine that the appraisal does not materially misstate or misrepresent the value of such dwelling.
(3)*Appraiser defined.* As used in this paragraph (b), an appraiser is a person who engages in the business of providing assessments of the value of dwellings. The term “appraiser” includes persons that employ, refer, or manage appraisers and affiliates of such persons.
(c)*Mortgage broker defined.* For purposes of this section, the term “mortgage broker” means a person, other than an employee of a creditor, who for compensation or other monetary gain, or in expectation of compensation or other monetary gain, arranges, negotiates, or otherwise obtains an extension of consumer credit. The term includes a person meeting this definition, even if the consumer credit obligation is initially payable to such person, unless the person provides the funds for the transaction at consummation out of the person's own resources, out of deposits held by the person, or by drawing on a bona fide warehouse line of credit.
(d)*Servicing practices.*
(1)In connection with a consumer credit transaction secured by a consumer's principal dwelling, no servicer shall—
(i)Fail to credit a payment to the consumer's loan account as of the date of receipt, except when a delay in crediting does not result in any charge to the consumer or in the reporting of negative information to a consumer reporting agency, or except as provided in paragraph (d)(2) of this section;
(ii)Impose on the consumer any late fee or delinquency charge in connection with a payment, when the only delinquency is attributable to late fees or delinquency charges assessed on an earlier payment, and the payment is otherwise a full payment for the applicable period and is paid on its due date or within an applicable grace period;
(iii)Fail to provide to the consumer within a reasonable time after receiving a consumer's request a schedule of all specific fees and charges that the servicer may impose on the consumer in connection with servicing the consumer's account, including a dollar amount and an explanation of each such fee and the circumstances under which it is imposed; or
(iv)Fail to provide, within a reasonable time after receiving a request from the consumer or any person acting on behalf of the consumer, an accurate statement of the total outstanding balance of the consumer's obligation that would be required to satisfy the obligation in full as of a specified date.
(2)If a servicer specifies in writing requirements for the consumer to follow in making payments, but accepts a payment that does not conform to the requirements, the servicer shall credit the payment within 5 days of receipt.
(3)For purposes of this paragraph (d), the terms “servicer” and “servicing” have the same meanings as provided in 24 CFR 3500.2(b), as amended.
(e)This section does not apply to a home equity line of credit subject to § 226.5b.◂ 11. In Supplement I to Part 226: a. Under *Section 226.2—Definitions and Rules of Construction, 2(a) Definitions, 2(a)(24) Residential Mortgage Transaction,* paragraphs 2(a)(24)-1 and 2(a)(24)-5 are revised. b. Under *Section 226.16—Advertising:* i. Paragraph 16-1 is revised, paragraph 16-2 is redesignated as paragraph 16-6, and new paragraphs 16-2 through 16-5 are added. ii. Under *16(d) Additional requirements for home equity plans,* paragraph 16(d)-3 is revised, paragraphs 16(d)-5, 16(d)-6, and 16(d)-7 are redesignated as paragraphs 16(d)-7, 16(d)-8, and 16(d)-9 respectively, newly designated paragraphs 16(d)-7 and 16(d)-9 and the heading of newly designated paragraph 16(d)-8 are revised, and new paragraphs 16(d)-5 and 16(d)-6 are added. c. Under *Section 226.17—General Disclosure Requirements, 17(c) Basis of disclosures and use of estimates, Paragraph 17(c)(1),* paragraph 17(c)(1)-8 is revised, and under *17(f) Early disclosures,* paragraph 17(f)-4 is revised. d. Under *Section 226.19—Certain Residential Mortgage and Variable-Rate Transactions,* the heading is revised, heading *19(a)(1) Time of disclosure* is redesignated as heading *19(a)(1)(i) Time of disclosure,* paragraphs 19(a)(1)(i)-1 and 19(a)(1)(i)-5 are revised, new headings *19(a)(1)(ii) Imposition of fees* and * 19(a)(1)(iii) Exception to fee restriction * are added, and new paragraphs 19(a)(1)(ii)-1, 19(a)(1)(ii)-2, and 19(a)(1)(iii)-1 are added. e. Under *Section 226.24—Advertising:* i. Paragraph 24-1 is removed; ii. Heading *24(d) Catalogues or other multiple-page advertisements; electronic advertisements* is redesignated as *24(e) Catalogues or other multiple-page advertisements; electronic advertisements,* and newly designated paragraphs 24(e)-1, 24(e)-2, and 24(e)-4 are revised; iii. Headings *24(c) Advertisement of terms that require additional disclosures, Paragraph 24(c)(1),* and *Paragraph 24(c)(2),* are redesignated as *24(d) Advertisement of terms that require additional disclosures, Paragraph 24(d)(1),* and *Paragraph 24(d)(2)* respectively, newly designated paragraphs 24(d)-1, 24(d)(1)-3, and 24(d)(2)-2 are revised, newly designated paragraphs 24(d)(2)-3 and 24(d)(2)-4 are further redesignated as paragraphs 24(d)(2)-4 and 24(d)(2)-5 respectively, new paragraph 24(d)(2)-3 is added, and newly designated paragraph 24(d)(2)-5 is revised; iv. Heading *24(b) Advertisement of rate of finance charge* is redesignated as *24(c) Advertisement of rate of finance charge,* and newly designated paragraphs 24(c)-2 and 24(c)-3 are revised, newly designated paragraph 24(c)-4 is removed, newly designated paragraph 24(c)-5 is redesignated as paragraph 24(c)-4 and revised, and newly designated paragraph 24(c)-6 is further redesignated as paragraph 24(c)-5. v. New heading *24(b) Clear and conspicuous standard* is added, and new paragraphs 24(b)-1 through 24(b)-5 are added; and vi. New headings *24(f) Disclosure of rates or payments in advertisements for credit secured by a dwelling, 24(f)(3) Disclosure of payments, 24(g) Alternative disclosures—television or radio advertisements, 24(h) Statements of tax deductibility, and 24(i) Prohibited acts or practices in advertisements for credit secured by a dwelling,* and new paragraphs 24(f)-1 through 24(f)-5, 24(f)(3)-1 and 24(f)(3)-2, 24(g)-1 through 24(g)-3, 24(h)-1, and 24(i)-1 through 24(i)-3 are added. f. Under *Section 226.32—Requirements for Certain Closed-End Home Mortgages, 32(a) Coverage:* i. New heading *Paragraph 32(a)(2)* and new paragraph 32(a)(2)-1 are added. ii. Under *32(d) Limitations,* new paragraph 32(d)-1 is added. iii. Under *32(d)(7) Prepayment penalty exception,* new paragraph 32(d)(7)-1 is added. iv. Under *Paragraph 32(d)(7)(iii),* paragraphs 32(d)(7)(iii)-1 and 32(d)(7)(iii)-2 are removed, and new paragraphs 32(d)(7)(iii)-1 through 32(d)(7)(iii)-4 are added. v. New heading *Paragraph 32(d)(7)(iv)* and new paragraphs 32(d)(7)(iv)-1 and 32(d)(7)(iv)-2 are added. g. Under *Section 226.34—Prohibited Acts or Practices in Connection with Credit Secured by a Consumer's Dwelling; Open-end Credit:* i. The heading is revised. ii. Under *34(a) Prohibited acts or practices for loans subject to § 226.32, 34(a)(4) Repayment ability,* paragraphs 34(a)(4)-3 and 34(a)(4)-4 are removed, paragraphs 34(a)(4)-1 and 34(a)(4)-2 are redesignated as paragraphs 34(a)(4)-3 and 34(a)(4)-4 respectively and revised, new paragraphs 34(a)(4)-1 and 34(a)(4)-2 are added, and new headings *Paragraph 34(a)(4)(i), Paragraph 34(a)(4)(i)(A), Paragraph 34(a)(4)(i)(B), Paragraph 34(a)(4)(i)(D),* and *Paragraph 34(a)(4)(i)(E)* and new paragraphs 34(a)(4)(i)-1, 34(a)(4)(i)(A)-1 and 34(a)(4)(i)(A)-2, 34(a)(4)(i)(B)-1, 34(a)(4)(i)(D)-1, and 34(a)(4)(i)(E)-1 are added. h. A new *Section 226.35—Prohibited Acts or Practices in Connection with Higher-priced Mortgage Loans* is added. i. A new *Section 226.36—Prohibited Acts or Practices in Connection with Credit Secured by a Consumer's Principal Dwelling* is added. Supplement I to Part 226—Official Staff Interpretations Subpart A—General Section 226.2—Definitions and Rules of Construction *2(a) Definitions.* *2(a)(24) Residential mortgage transaction.* 1. *Relation to other sections.* This term is important in [six] ▸five◂ provisions in the regulation: [•] ▸i.◂ § 226.4(c)(7)—exclusions from the finance charge. [•] ▸ii.◂ § 226.15(f)—exemption from the right of rescission. [•] ▸iii.◂ § 226.18(q)—whether or not the obligation is assumable. [• Section 226.19—special timing rules.] [•] ▸iv.◂ § 226.20(b)—disclosure requirements for assumptions. [•] ▸v.◂ § 226.23(f)—exemption from the right of rescission. 5. *Acquisition.* i. A residential mortgage transaction finances the acquisition of a consumer's principal dwelling. The term does not include a transaction involving a consumer's principal dwelling if the consumer had previously purchased and acquired some interest to the dwelling, even though the consumer had not acquired full legal title. ii. Examples of new transactions involving a previously acquired dwelling include the financing of a balloon payment due under a land sale contract and an extension of credit made to a joint owner of property to buy out the other joint owner's interest. In these instances, disclosures are not required under § 226.18(q) [or section 226.19(a)] (assumability policies [and early disclosures for residential mortgage transactions]). However, the rescission rules of §§ 226.15 and 226.23 do apply to these new transactions. iii. In other cases, the disclosure and rescission rules do not apply. For example, where a buyer enters into a written agreement with the creditor holding the seller's mortgage, allowing the buyer to assume the mortgage, if the buyer had previously purchased the property and agreed with the seller to make the mortgage payments, § 226.20(b) does not apply (assumptions involving residential mortgages). Subpart B—Open-End Credit Section 226.16—Advertising 1. *Clear and conspicuous standard* ▸— *general* ◂. Section 226.16 is subject to the general “clear and conspicuous” standard for subpart B (see § 226.5(a)(1)) but prescribes no specific rules for the format of the necessary disclosures[.]▸, aside from the format requirements related to the disclosure of an introductory rate under §§ 226.16(d)(6) and 226.16(e). Aside from the terms described in §§ 226.16(d)(6) and 226.16(e), the◂ [The] credit terms need not be printed in a certain type size nor need they appear in any particular place in the advertisement. ▸2. *Clear and conspicuous standard-introductory rates or payments for home—equity plans.* For purposes of § 226.16(d)(6), a clear and conspicuous disclosure means that the required information in § 226.16(d)(6)(iii)(A)-(C) is disclosed with equal prominence and in close proximity to the introductory rate or payment to which it applies. If the information in § 226.16(d)(6)(iii)(A)-(C) is the same type size and is located immediately next to or directly above or below the introductory rate or payment to which it applies, without any intervening text or graphical displays, the disclosures would be deemed to be equally prominent and in close proximity. Notwithstanding the above, for electronic advertisements that disclose introductory rates or payments, compliance with the requirements of § 226.16(c) is deemed to satisfy the clear and conspicuous standard. 3. *Clear and conspicuous standard—Internet advertisements for home-equity plans.* For purposes of this section, a clear and conspicuous disclosure for visual text advertisements on the Internet for home-equity plans subject to the requirements of § 226.5b means that the required disclosures are not obscured by techniques such as graphical displays, shading, coloration, or other devices and comply with all other requirements for clear and conspicuous disclosures under § 226.16(d). *See also* comment 16(c)(1)-2. 4. *Clear and conspicuous standard—televised advertisements for home-equity plans.* For purposes of this section, and except as otherwise provided by § 226.16(f) for alternative disclosures, a clear and conspicuous disclosure in the context of visual text advertisements on television for home-equity plans subject to the requirements of § 226.5b means that the required disclosures are not obscured by techniques such as graphical displays, shading, coloration, or other devices, are displayed in a manner that allows for a consumer to read the information required to be disclosed, and comply with all other requirements for clear and conspicuous disclosures under § 226.16(d). For example, very fine print in a television advertisement would not meet the clear and conspicuous standard if consumers cannot see and read the information required to be disclosed. 5. *Clear and conspicuous standard—oral advertisements for home-equity plans.* For purposes of this section, and except as otherwise provided by § 226.16(f) for alternative disclosures, a clear and conspicuous disclosure in the context of an oral advertisement for home-equity plans subject to the requirements of § 226.5b, whether by radio, television, the Internet, or other medium, means that the required disclosures are given at a speed and volume sufficient for a consumer to hear and comprehend them. For example, information stated very rapidly at a low volume in a radio or television advertisement would not meet the clear and conspicuous standard if consumers cannot hear and comprehend the information required to be disclosed.◂ ▸6.◂ [2.] *Expressing the annual percentage rate in abbreviated form.* * * * *16(d) Additional requirements for home-equity plans.* 3. *Statements of tax deductibility.* An advertisement referring to deductibility for tax purposes is not misleading if it includes a statement such as “consult a tax advisor regarding the deductibility of interest.” ▸An advertisement for a home-equity plan where the plan's terms do not allow for extensions of credit greater than the fair market value of the consumer's dwelling need not give the disclosures regarding which portion of the interest is tax deductible. An advertisement for such a plan is not required to refer to deductibility for tax purposes; however, if it does so, it must not be misleading in this regard.◂ ▸5. *Introductory rates and payments in advertisements for home-equity plans.* Section 226.16(d)(6) requires additional disclosures for introductory rates or payments. i. *Variable-rate plans.* In advertisements for variable-rate plans, if the advertised annual percentage rate is based on (or the advertised payment is derived from) the index and margin that will be used to make rate (or payment) adjustments over the term of the loan, then there is no introductory rate or introductory payment. If, however, the advertised annual percentage rate is not based on (or the advertised payment is not derived from) the index and margin that will be used to make rate (or payment) adjustments, and a reasonably current application of the index and margin would result in a higher annual percentage rate (or, given an assumed balance, a higher payment) then there is an introductory rate or introductory payment. ii. *Immediate proximity.* Including the term “introductory” or “intro” in the same sentence as the listing of the introductory rate or payment is deemed to be in immediate proximity of the listing. iii. *Equal prominence, close proximity.* Information required to be disclosed in § 226.16(d)(6)(iii) that is in the same paragraph as the introductory rate or payment (not in a footnote to that paragraph) is deemed to be closely proximate to the listing. Information required to be disclosed in § 226.16(d)(6)(iii) that is in the same type size as the introductory rate or payment is deemed to be equally prominent. iv. *Amounts and time periods of payments.* Section 226.16(d)(6)(iii)(C) requires disclosure of the amount and time periods of any payments that will apply under the plan. This section may require disclosure of several payment amounts, including any balloon payment. For example, if an advertisement for a home-equity plan offers a $100,000 five-year line of credit and assumes that the entire line is drawn resulting in a payment of $800 per month for the first six months, increasing to $1,000 per month after month six, followed by a $50,000 balloon payment after five years, the advertisement must disclose the amount and time period of each of the two monthly payment streams, as well as the amount and timing of the balloon payment, with equal prominence and in close proximity to the introductory payment. v. *Plans other than variable-rate plans.* For a plan other than a variable-rate plan, if an advertised payment is calculated in the same way as other payments based on an assumed balance, the fact that the payment could increase solely if the consumer made an additional draw does not make the payment an introductory payment. For example, if a payment of $500 results from an assumed $10,000 draw, and the payment would increase to $1000 if the consumer made an additional $10,000 draw, the payment is not an introductory payment. 6. *Reasonably current index and margin.* For the purposes of this section, an index and margin is considered reasonably current if: i. For direct mail advertisements, it was in effect within 60 days before mailing; ii. For advertisements in electronic form, it was in effect within 30 days before the advertisement is sent to a consumer's e-mail address, or in the case of an advertisement made on an Internet Web site, when viewed by the public; or iii. For printed advertisements made available to the general public, including ones contained in a catalog, magazine, or other generally available publication, it was in effect within 30 days before printing. 7.◂[5.] *Relation to other sections.* Advertisements for home-equity plans must comply with all provisions in § 226.16, ▸except for § 226.16(e),◂ not solely the rules in § 226.16(d). If an advertisement contains information (such as the payment terms) that triggers the duty under § 226.16(d) to state the annual percentage rate, the additional disclosures in § 226.16(b) must be provided in the advertisement. While § 226.16(d) does not require a statement of fees to use or maintain the plan (such as membership fees and transaction charges), such fees must be disclosed under § 226.16(b)(1) and (3). ▸8.◂[6.] *Inapplicability of closed-end rules.* * * * ▸9.◂[7.] *Balloon payment* . [In some programs, a balloon payment will occur if only the minimum payments under the plan are made. If an advertisement for such a program contains any statement about a minimum periodic payment, the advertisement must also state that a balloon payment will result (not merely that a balloon payment “may” result). (]See comment 5b(d)(5)(ii)-3 for [guidance on items] ▸information◂ not required to be stated in [the] advertisement▸s◂, and on situations in which the balloon payment requirement does not apply.[)] Subpart C—Closed-End Credit Section 226.17—General Disclosure Requirements *17(c) Basis of disclosures and use of estimates* . *Paragraph 17(c)(1)* . 8. *Basis of disclosures in variable-rate transactions* . The disclosures for a variable-rate transaction must be given for the full term of the transaction and must be based on the terms in effect at the time of consummation. Creditors should base the disclosures only on the initial rate and should not assume that this rate will increase. For example, in a loan with an initial rate of 10 percent and a 5 percentage points rate cap, creditors should base the disclosures on the initial rate and should not assume that this rate will increase 5 percentage points. However, in a variable-rate transaction with a seller buydown that is reflected in the credit contract, a consumer buydown, or a discounted or premium rate, disclosures should not be based solely on the initial terms. In those transactions, the disclosed annual percentage rate should be a composite rate based on the rate in effect during the initial period and the rate that is the basis of the variable-rate feature for the remainder of the term. (See the commentary to § 226.17(c) for a discussion of buydown, discounted, and premium transactions and the commentary to § 226.19(a)(2) for a discussion of the redisclosure in certain [residential] mortgage transactions with a variable-rate feature). *17(f) Early disclosures* . 4. *Special rules* . In [residential] mortgage transactions subject to § 226.19, the creditor must redisclose if, between the delivery of the required early disclosures and consummation, the annual percentage rate changes by more than a stated tolerance. When subsequent events occur after consummation, new disclosures are required only if there is a refinancing or an assumption within the meaning of § 226.20. Section 226.19—Certain [Residential] Mortgage and Variable-Rate Transactions 19(a)(1)▸(i)◂ Time of disclosure. 1. *Coverage* . This section requires early disclosure of credit terms in [residential] mortgage transactions that are ▸secured by a consumer's principal dwelling and◂ also subject to the Real Estate Settlement Procedures Act (RESPA) and its implementing Regulation X, administered by the Department of Housing and Urban Development (HUD). To be covered by § 226.19, a transaction must be [both a residential mortgage transaction under section 226.2(a) and] a federally related mortgage loan under RESPA. “Federally related mortgage loan” is defined under RESPA (12 U.S.C. 2602) and Regulation X (24 CFR 3500.[5(b)]▸2◂), and is subject to any interpretations by HUD.▸ RESPA coverage includes such transactions as loans to purchase dwellings, refinancings of loans secured by dwellings, and subordinate-lien home-equity loans, among others. Although RESPA coverage relates to any dwelling, § 226.19(a) applies to such transactions only if they are secured by a consumer's principal dwelling. Also, home equity lines of credit subject to § 226.5b are not covered by § 226.19(a).◂ 5. *Itemization of amount financed* . In many [residential] mortgage transactions, the itemization of the amount financed required by § 226.18(c) will contain items, such as origination fees or points, that also must be disclosed as part of the good faith estimates of settlement costs required under RESPA. Creditors furnishing the RESPA good faith estimates need not give consumers any itemization of the amount financed, either with the disclosures provided within three days after application or with the disclosures given at consummation or settlement. ▸ *19(a)(1)(ii) Imposition of fees* . 1. *Timing of fees* . The consumer must receive the disclosures required by this section before paying any fee to a creditor or other person in connection with the consumer's application for a mortgage transaction that is subject to § 226.19(a)(1)(i), except as provided in § 226.19(a)(1)(iii). If the creditor delivers the disclosures to the consumer in person, a fee may be imposed anytime after delivery. If the creditor places the disclosures in the mail, the creditor may impose a fee after the consumer receives the disclosures or, in all cases, on or after the fourth business day after mailing the disclosure. 2. *Fees restricted* . A creditor or other person may not charge any fee other than to obtain a consumer's credit history, such as for a credit report(s), until the consumer has received the disclosures required by § 226.19(a)(1)(i). For example, until the consumer has received the disclosures, the creditor may not impose a fee on the consumer for an appraisal or for underwriting. *19(a)(1)(iii) Exception to fee restriction* . 1. *Requirements for exception* . A creditor or other person may impose a fee before the consumer receives the required disclosures if it is for obtaining information on the consumer's credit history, such as by purchasing a credit report(s) on the consumer. The fee also must be *bona fide* and reasonable in amount. For example, a creditor may collect a fee for obtaining a credit report(s) if it is the creditor's ordinary practice to obtain such credit history information. The creditor may refer to this fee as an “application fee.”◂ Section 226.24—Advertising [1. *Clear and conspicuous standard* . This section is subject to the general “clear and conspicuous” standard for this subpart but prescribes no specific rules for the format of the necessary disclosures. The credit terms need not be printed in a certain type size nor need they appear in any particular place in the advertisement. For example, a merchandise tag that is an advertisement under the regulation complies with this section if the necessary credit terms are on both sides of the tag, so long as each side is accessible.] ▸ *24(b) Clear and conspicuous standard.* 1. *Clear and conspicuous standard—general* . This section is subject to the general “clear and conspicuous” standard for this subpart, *see* § 226.17(a)(1), but prescribes no specific rules for the format of the necessary disclosures, other than the format requirements related to the advertisement of rates and payments as described in comment 24(b)-2 below. The credit terms need not be printed in a certain type size nor need they appear in any particular place in the advertisement. For example, a merchandise tag that is an advertisement under the regulation complies with this section if the necessary credit terms are on both sides of the tag, so long as each side is accessible. 2. *Clear and conspicuous standard—rates and payments in advertisements for credit secured by a dwelling* . For purposes of § 226.24(f), a clear and conspicuous disclosure means that the required information in §§ 226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and
(B)is disclosed with equal prominence and in close proximity to the advertised rates or payments triggering the required disclosures, and that the required information in § 226.24(f)(3)(i)(C) is disclosed with prominence and in close proximity to the advertised rates or payments triggering the required disclosures. If the required information in §§ 226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and
(B)is the same type size as the advertised rates or payments triggering the required disclosures, the disclosures are deemed to be equally prominent. The information in § 226.24(f)(3)(i)(C) must be disclosed with prominence, but need not be disclosed with equal prominence or be the same type size as the payments triggering the required disclosures. If the required information in §§ 226.24(f)(2)(i) and 226.24(f)(3)(i) is located immediately next to or directly above or below the advertised rates or payments triggering the required disclosures, without any intervening text or graphical displays, the disclosures are deemed to be in close proximity. Notwithstanding the above, for electronic advertisements that disclose rates or payments, compliance with the requirements of § 226.24(e) is deemed to satisfy the clear and conspicuous standard. 3. *Clear and conspicuous standard—Internet advertisements for credit secured by a dwelling* . For purposes of this section, a clear and conspicuous disclosure for visual text advertisements on the Internet for credit secured by a dwelling means that the required disclosures are not obscured by techniques such as graphical displays, shading, coloration, or other devices and comply with all other requirements for clear and conspicuous disclosures under § 226.24. *See also* comment 24(e)-4. 4. *Clear and conspicuous standard—televised advertisements for credit secured by a dwelling* . For purposes of this section, and except as otherwise provided by § 226.24(g) for alternative disclosures, a clear and conspicuous disclosure in the context of visual text advertisements on television for credit secured by a dwelling means that the required disclosures are not obscured by techniques such as graphical displays, shading, coloration, or other devices, are displayed in a manner that allows a consumer to read the information required to be disclosed, and comply with all other requirements for clear and conspicuous disclosures under § 226.24. For example, very fine print in a television advertisement would not meet the clear and conspicuous standard if consumers cannot see and read the information required to be disclosed. 5. *Clear and conspicuous standard—oral advertisements for credit secured by a dwelling* . For purposes of this section, and except as otherwise provided by § 226.24(g) for alternative disclosures, a clear and conspicuous disclosure in the context of an oral advertisement for credit secured by a dwelling, whether by radio, television, or other medium, means that the required disclosures are given at a speed and volume sufficient for a consumer to hear and comprehend them. For example, information stated very rapidly at a low volume in a radio or television advertisement would not meet the clear and conspicuous standard if consumers cannot hear and comprehend the information required to be disclosed.◂ *24▸(c)◂* [ *(b)* ] *Advertisement of rate of finance charge* . 2. *Simple or periodic rates* . The advertisement may not simultaneously state any other rate, except that a simple annual rate or periodic rate applicable to an unpaid balance may appear along with (but not more conspicuously than) the annual percentage rate. ▸An advertisement for credit secured by a dwelling may not state a periodic rate, other than a simple annual rate, that is applied to an unpaid balance.◂ For example▸,◂[:] [• I]▸i◂n an advertisement for [real estate] ▸credit secured by a dwelling◂, a simple ▸annual◂ interest rate may be shown in the same type size as the annual percentage rate for the advertised credit▸, subject to the requirements of section 226.24(f)◂. ▸A simple annual rate or periodic rate that is applied to an unpaid balance is the rate at which interest is accruing; those terms do not include a rate lower than the rate at which interest is accruing, such as an effective rate, payment rate, or qualifying rate.◂ 3. *Buydowns* . When a third party (such as a seller) or a creditor wishes to promote the availability of reduced interest rates (consumer or seller buydowns), the advertised annual percentage rate must be determined in accordance with [the rules in] the commentary to § 226.17(c) regarding the basis of transactional disclosures for buydowns. The seller or creditor may advertise the reduced simple interest rate, provided the advertisement shows the limited term to which the reduced rate applies and states the simple interest rate applicable to the balance of the term. The advertisement may also show the effect of the buydown agreement on the payment schedule for the buydown period▸, but this will◂ [without] trigger[ing] the additional disclosures under § 226.24▸(d)◂[(c)](2). [For example, the advertisement may state that “with this buydown arrangement, your monthly payments for the first three years of the mortgage term will be only $350” or “this buydown arrangement will reduce your monthly payments for the first three years of the mortgage term by $150.”] [4. *Effective rates* . In some transactions the consumer's payments may be based upon an interest rate lower than the rate at which interest is accruing. The lower rate may be referred to as the effective rate, payment rate, or qualifying rate. A creditor or seller may advertise such rates by stating the term of the reduced payment schedule, the interest rate upon which the reduced payments are calculated, the rate at which the interest is in fact accruing, and the annual percentage rate. The advertised annual percentage rate that must accompany this rate must take into account the interest that will accrue but will not be paid during this period. For example, an advertisement may state, “An effective first-year interest rate of 10 percent. Interest being earned at 14 percent. Annual percentage rate 15 percent.”] ▸4◂[5]. *Discounted variable-rate transactions* . The advertised annual percentage rate for discounted variable-rate transactions must be determined in accordance with comment 17(c)(1)-10 regarding the basis of transactional disclosures for such financing. ▸i.◂ A creditor or seller may promote the availability of the initial rate reduction in such transactions by advertising the reduced [initial] ▸simple annual◂ rate, provided the advertisement shows ▸with equal prominence and in close proximity◂ the limited term to which the reduced rate applies ▸and the annual percentage rate that will apply after the term of the initial rate reduction expires. *See* § 226.24(f)◂. ▸ii.◂[•] Limits or caps on periodic rate or payment adjustments need not be stated. To illustrate using the second example in comment 17(c)(1)-10, the fact that the rate is presumed to be 11 percent in the second year and 12 percent for the remaining 28 years need not be included in the advertisement. ▸iii.◂[•] The advertisement may also show the effect of the discount on the payment schedule for the discount period▸, but this will◂ [without] trigger[ing] the additional disclosures under § 226.24(d). [For example, the advertisement may state that “with this discount, your monthly payments for the first year of the mortgage term will be only $577” or “this discount will reduce your monthly payments for the first year of mortgage term by $223.”] *24▸(d)◂* [ *(c)* ] *Advertisement of terms that require additional disclosures.* 1. *General rule.* Under § 226.24▸(d)◂[(c)](1), whenever certain triggering terms appear in credit advertisements, the additional credit terms enumerated in § 226.24▸(d)◂[(c)](2) must also appear. These provisions apply even if the triggering term is not stated explicitly but may be readily determined from the advertisement. For example, an advertisement may state “80 percent financing available,” which is in fact indicating that a 20 percent downpayment is required. *Paragraph 24▸(d)◂* [ *(c)* ] *(1).* 3. *Payment amount.* The dollar amount of any payment includes statements such as: • “Payable in installments of $103” • “$25 weekly” ▸• “$500,000 loan for just $1,650 per month”◂ • “$1,200 balance payable in 10 equal installments” In the last example, the amount of each payment is readily determinable, even though not explicitly stated. But statements such as “monthly payments to suit your needs” or “regular monthly payments” are not covered. *Paragraph 24▸(d)◂* [ *(c)* ]( *2).* 2. *Disclosure of repayment terms.* [While t]▸T◂he phrase “terms of repayment” generally has the same meaning as the “payment schedule” required to be disclosed under § 226.18(g)▸.◂[,] [s]▸S◂ection 226.24▸(d)◂[(c)](2)(ii) provides [greater] flexibility to creditors in making this disclosure for advertising purposes. Repayment terms may be expressed in a variety of ways in addition to an exact repayment schedule; this is particularly true for advertisements that do not contemplate a single specific transaction. ▸Repayment terms, however, must reflect the consumer's repayment obligations over the full term of the loan, including any balloon payment, *see* comment 24(d)(2)(iii), not just the repayment terms that will apply for a limited period of time.◂ For example: ▸i.◂[•] A creditor may use a unit-cost approach in making the required disclosure, such as “48 monthly payments of $27.83 per $1,000 borrowed.” [• In an advertisement for credit secured by a dwelling, when any series of payments varies because of a graduated-payment feature or because of the inclusion of mortgage insurance premiums, a creditor may state the number and timing of payments, and the amounts of the largest and smallest of those payments, and the fact that other payments will vary between those amounts.] ▸ii. In an advertisement for credit secured by a dwelling, when any series of payments varies because of the inclusion of mortgage insurance premiums, a creditor may state the number and timing of payments, the amounts of the largest and smallest of those payments, and the fact that other payments will vary between those amounts. iii. In an advertisement for credit secured by a dwelling, when one series of monthly payments will apply for a limited period of time followed by a series of higher monthly payments for the remaining term of the loan, the advertisement must state the number and time period of each series of payments, and the amounts of each of those payments. For this purpose, the creditor must assume that the consumer makes the lower series of payments for the maximum allowable period of time. 3. *Balloon payment; disclosure of repayment terms.* In some transactions, a balloon payment will occur when the consumer only makes the minimum payments specified in an advertisement. A balloon payment results if paying the minimum payments does not fully amortize the outstanding balance by a specified date or time, usually the end of the term of the loan, and the consumer must repay the entire outstanding balance at such time. If a balloon payment will occur when the consumer only makes the minimum payments specified in an advertisement, the advertisement must state with equal prominence and in close proximity to the minimum payment statement the amount and timing of the balloon payment that will result if the consumer makes only the minimum payments for the maximum period of time that the consumer is permitted to make such payments. 4.◂[3.] *Annual percentage rate.* The advertised annual percentage rate may be expressed using the abbreviation APR. The advertisement must also state, if applicable, that the annual percentage rate is subject to increase after consummation. ▸5.◂[4.] *Use of examples.* ▸A creditor may use◂ [Footnote 49 authorizes the use of] illustrative credit transactions to make the necessary disclosures under § 226.24▸(d)◂[(c)](2). That is, where a range of possible combinations of credit terms is offered, the advertisement may use examples of typical transactions, so long as each example contains all of the applicable terms required by § 226.24▸(d)◂[(c)]. The examples must be labeled as such and must reflect representative credit terms [that are] made available by the creditor to present and prospective customers. *24▸(e)◂* [ *(d)* ] *Catalogs or other multiple-page advertisements; electronic advertisements.* 1. *Definition.* The multiple-page advertisements to which this section refers are advertisements consisting of a series of sequentially numbered pages—for example, a supplement to a newspaper. A mailing consisting of several separate flyers or pieces of promotional material in a single envelope does not constitute a single multiple-page advertisement for purposes of § 226.24▸(e)◂[(d)]. 2. *General.* Section 226.24▸(e)◂[(d)] permits creditors to put credit information together in one place in a catalog or other multiple-page advertisement or in an electronic advertisement (such as an advertisement appearing on an Internet Web site). The rule applies only if the advertisement contains one or more of the triggering terms from § 226.24▸(d)◂[(c)](1). A list of different annual percentage rates applicable to different balances, for example, does not trigger further disclosures under § 226.24▸(d)◂[(c)](2) and so is not covered by § 226.24▸(e)◂[(d)]. 4. *Electronic advertisement.* If an electronic advertisement (such as an advertisement appearing on an Internet Web site) contains the table or schedule permitted under § 226.24▸(e)◂[(d)](1), any statement of terms set forth in § 226.24▸(d)◂[(c)](1) appearing anywhere else in the advertisement must clearly direct the consumer to the location where the table or schedule begins. For example, a term triggering additional disclosures may be accompanied by a link that directly takes the consumer to the additional information. *▸24(f) Disclosure of rates and payments in advertisements for credit secured by a dwelling.* 1. *Equal prominence, close proximity.* Information required to be disclosed under §§ 226.24(f)(2)(i) and 226.24(f)(3)(i) that is in the same paragraph as the simple annual rate or payment amount (not in a footnote to that paragraph) is deemed to be closely proximate to the listing. Information required to be disclosed under §§ 226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and
(B)that is in the same type size as the simple annual rate or payment amount is deemed to be equally prominent. 2. *Clear and conspicuous standard.* For more information about the applicable clear and conspicuous standard, see comment 24(b)-2. 3. *Comparisons in advertisements.* When making any comparison in an advertisement between an actual or hypothetical consumer's current credit payments or rates and the payments or rates available under the advertised product, the advertisement must state all applicable payments or rates for the advertised product and the time periods for which those payments or rates will apply, as required by this section. 4. *Application to variable-rate transactions—disclosure of rates.* In advertisements for variable-rate transactions, if a simple annual rate that applies at consummation is not based on the index and margin that will be used to make subsequent rate adjustments over the term of the loan, the requirements of § 226.24(f)(2)(i) apply. 5. *Reasonably current index and margin.* For the purposes of this section, an index and margin is considered reasonably current if: i. For direct mail advertisements, it was in effect within 60 days before mailing; ii. For advertisements in electronic form, it was in effect within 30 days before the advertisement is sent to a consumer's e-mail address, or in the case of an advertisement made on an Internet Web site, when viewed by the public; or iii. For printed advertisements made available to the general public, including ones contained in a catalog, magazine, or other generally available publication, it was in effect within 30 days before printing. *24(f)(3) Disclosure of payments.* 1. *Amounts and time periods of payments.* Section 226.24(f)(3)(i) requires disclosure of the amounts and time periods of all payments that will apply over the term of the loan. This section may require disclosure of several payment amounts, including any balloon payment. For example, if an advertisement for credit secured by a dwelling offers $300,000 of credit with a 30-year loan term for a payment of $600 per month for the first six months, increasing to $1,500 per month after month six, followed by a balloon payment of $30,000 at the end of the loan term, the advertisement must disclose the amount and time periods of each of the two monthly payment streams, as well as the amount and timing of the balloon payment, with equal prominence and in close proximity to each other. 2. *Application to variable-rate transactions—disclosure of payments.* In advertisements for variable-rate transactions, if the payment that applies at consummation is not based on the index and margin that will be used to make subsequent payment adjustments over the term of the loan, the requirements of § 226.24(f)(3)(i) apply. *24(g) Alternative disclosures—television or radio advertisements.* 1. *Toll-free number, local or collect calls.* In complying with the disclosure requirements of § 226.24(g), an advertisement must provide a toll-free telephone number. Alternatively, an advertisement may provide any telephone number that allows a consumer to reverse the phone charges when calling for information. 2. *Multi-purpose number.* When an advertised toll-free telephone number provides a recording, disclosures should be provided early in the sequence to ensure that the consumer receives the required disclosures. For example, in providing several options—such as providing directions to the advertiser's place of business—the option allowing the consumer to request disclosures should be provided early in the telephone message to ensure that the option to request disclosures is not obscured by other information. 3. *Statement accompanying toll free number.* Language must accompany a telephone number indicating that disclosures are available by calling the toll-free number, such as “call 1-800-000-0000 for details about credit costs and terms.” *24(h) Statements of tax deductibility. * 1. *When disclosures not required.* An advertisement for a home-secured loan where the loan's terms do not allow for extensions of credit greater than the fair market value of the consumer's dwelling need not give the disclosures regarding which portions of the interest are tax deductible. *24(i) Prohibited acts or practices in advertisements for credit secured by a dwelling.* 1. *Misleading comparisons in advertisements—savings claims.* A misleading comparison includes a claim about the amount a consumer may save under the advertised product. For example, a statement such as “save $300 per month on a $300,000 loan” constitutes an implied comparison between the advertised product's payment and a consumer's current payment. 2. *Misrepresentations about government endorsement.* A statement that the federal Community Reinvestment Act entitles the consumer to refinance his or her mortgage at the low rate offered in the advertisement is prohibited because it conveys a misleading impression that the advertised product is endorsed or sponsored by the federal government. 3. *Misleading claims of debt elimination.* The prohibition against misleading claims of debt elimination or waiver or forgiveness does not apply to claims that the advertised product may reduce debt payments, consolidate debts, or shorten the term of the debt. Examples of misleading claims of debt elimination or waiver or forgiveness of loan terms with, or obligations to, another creditor of debt include: “Wipe-Out Personal Debts!”, “New DEBT-FREE Payment”, “Set yourself free; get out of debt today”, “Refinance today and wipe your debt clean!”, “Get yourself out of debt * * * Forever!”, and “Pre-payment Penalty Waiver.”◂ Subpart E—Special Rules for Certain Home Mortgage Transactions Section 226.32—Requirements for Certain Closed-End Home Mortgages *32(a) Coverage.* ▸ *Paragraph 32(a)(2)* 1. *Exemption limited.* Section 226.32(a)(2) lists certain transactions as being exempt from the provisions of § 226.32. Nevertheless, those transactions may be subject to the provisions of § 226.35, including any provisions of § 226.32 to which § 226.35 refers. *See* 12 CFR 226.35(a).◂ *32(d) Limitations.* ▸1. *Additional prohibitions applicable under other sections.* Section 226.34 sets forth certain prohibitions in connection with mortgage credit subject to § 226.32, in addition to the limitations in § 226.32(d). Further, § 226.35(b) prohibits certain practices in connection with transactions that meet the coverage test in § 226.35(a). Because the coverage test in § 226.35(a) is generally broader than the coverage test in § 226.32(a), most § 226.32 mortgage loans are also subject to the prohibitions set forth in § 226.35(b), in addition to the limitations in § 226.32(d).◂ *32(d)(7) Prepayment penalty exception.* ▸1. *Other application of section.* The conditions in § 226.32(d)(7) apply to prepayment penalties on mortgage transactions described in § 226.32(a). In addition, these conditions apply to mortgage transactions covered by § 226.35(a).◂ *Paragraph 32(d)(7)(iii).* [1. *Calculating debt-to-income ratio.* “Debt” does not include amounts paid by the borrower in cash at closing or amounts from the loan proceeds that directly repay an existing debt. Creditors may consider combined debt-to-income ratios for transactions involving joint applicants. 2. *Verification.* Verification of employment satisfies the requirement for payment records for employment income.] ▸1. *Classifying debt and income.* To determine whether to classify particular funds or obligations as “debt” or “income” under the prepayment penalty exception in § 226.32(d)(7)(iii), creditors may look to widely accepted governmental and non-governmental underwriting standards, including, for example, those set forth in the Federal Housing Administration's handbook on Mortgage Credit Analysis for Mortgage Insurance on One-to Four-Unit Mortgage Loans. 2. *Debt described.* i. For purposes of § 226.32(d)(7)(iii), “debt” includes, but is not limited to, the consumer's liabilities and obligations for: A. Housing expenses; B. Loans such as installment and real estate loans; C. Open-end credit plans; and D. Alimony, child support, and separate maintenance. ii. “Debt” does not include amounts paid by a borrower in cash at closing or amounts from the loan proceeds that directly repay an existing debt. 3. *Income described.* For purposes of § 226.32(d)(7)(iii), “income” includes, but is not limited to, funds a consumer receives: i. From employment (whether full-time, part-time, seasonal, military, or self-employment), including without limitation salary, wages, base pay, overtime pay, bonus pay, tips, and commissions; ii. As interest or dividends; iii. As retirement benefits or public assistance; and iv. As alimony, child support, or separate maintenance payments, to the extent permitted under Regulation B, 12 CFR 202.5(d)(2), 202.6(b)(5). 4. *Verification.* Creditors shall verify income in the manner described in § 226.35(b)(2)(i) and the related comments. Creditors may verify debt with a credit report. *Paragraph 32(d)(7)(iv).* 1. *Changes in payment amounts.* Section 226.32(d)(7)(iv) permits a prepayment penalty only if the period during which the penalty may be imposed ends at least sixty days prior to the first date, if any, on which the principal or interest payment amount may increase under the terms of the loan. This permits a consumer to refinance or otherwise pay off all or part of the loan, without a penalty, sixty days before there is an increase in the payment of interest or principal. For example, the principal or interest payment amount may increase because— i. The loan's interest rate increases; ii. Scheduled payments of principal or interest increase independently of interest rate changes, for example with a graduated or step-rate transaction; or iii. Negative amortization occurs and, under the loan terms, triggers an increase in principal or interest payment amounts. 2. *Payment increases excluded from § 226.32(d)(7)(iv).* Payment increases due to the following circumstances are not considered payment increases for purposes of § 226.32(d)(7)(iv): i. Actual unanticipated late payment, the borrower's delinquency, or default; and ii. Increased payments made solely at the consumer's option, such as when a consumer chooses to make a payment of interest and principal on a loan that only requires the consumer to pay interest.◂ Section 226.34—Prohibited Acts or Practices in Connection with Credit [Secured by a Consumer's Dwelling; Open-end Credit] ▸Subject to § 226.32◂ *34(a) Prohibited acts or practices for loans subject to § 226.32.* *34(a)(4) Repayment ability.* ▸1. *Application of repayment ability rule to § 226.35(a) higher-cost mortgage loans.* The § 226.34(a)(4) prohibition against a pattern or practice of making loans without regard to consumers' repayment ability applies to creditors making mortgage loans described in § 226.32(a). In addition, the § 226.34(a)(4) prohibition applies to creditors making higher-cost mortgage transactions, including residential mortgage transactions, described in § 226.35(a). *See* 12 CFR 226.35(b)(1). 2. *Determination as of consummation.* Section 226.34(a)(4) prohibits a creditor from engaging in a pattern or practice of extending credit subject to § 226.32 to consumers based on the value of consumers' collateral without regard to consumers' repayment ability as of consummation. This prohibition is based on the facts and circumstances that existed as of consummation. Events after consummation may be relevant to determining whether a creditor has violated § 226.34(a)(4), but events after consummation do not, by themselves, establish a violation. For example, a violation is not established if borrowers default after consummation because of serious illness or job loss.◂ [1.]▸3.◂ *Income▸, assets, and employment* ◂. Any ▸current or reasonably expected assets or current or reasonably◂ expected income [can] ▸may◂ be considered by the creditor, except ▸the collateral itself◂ [equity income that would be realized from collateral]. For example, a creditor may use information about ▸current or expected◂ income other than regular salary or wages, such as income described in paragraph 226.32(d)(7)(iii)-(3) [such as gifts, expected retirement payments, or income from self-employment, such as housecleaning or childcare]. ▸Employment should also be considered. In some circumstances, it may be appropriate or necessary to take into account expected changes in employment. For example, depending on all of the facts and circumstances, it may be reasonable to assume that students obtaining professional degrees or certificates will obtain employment upon receiving the degree or certificate. In other circumstances, a creditor may have information indicating that an employed person will become unemployed. A creditor may also take into account assets such as savings accounts or investments that can be used by the consumer.◂ [2.]▸4.◂ *Pattern or practice of extending credit—repayment ability.* Whether a creditor [is engaging in or] has engaged in a pattern or practice of violations of this section depends on the totality of the circumstances in the particular case. While a pattern or practice is not established by isolated, random, or accidental acts, it can be established without the use of a statistical process. In addition, a creditor might act under a lending policy (whether written or unwritten) and that action alone could establish a pattern or practice of making loans in violation of this section. [3. *Discounted introductory rates.* In transactions where the creditor sets an initial interest rate to be adjusted later (whether fixed or to be determined by an index or formula), in determining repayment ability the creditor must consider the consumer's ability to make loan payments based on the non-discounted or fully-indexed rate at the time of consummation.] [4. *Verifying and documenting income and obligations* . Creditors may verify and document a consumer's repayment ability in various ways. A creditor may verify and document a consumer's income and current obligations through any reliable source that provides the creditor with a reasonable basis for believing that there are sufficient funds to support the loan. Reliable sources include, but are not limited to, a credit report, tax returns, pension statements, and payment records for employment income.] ▸ *Paragraph 34(a)(4)(i)* . 1. *Presumptions* . Section 226.34(a)(4)(i) sets forth particular patterns or practices that would create a presumption that a creditor has violated § 226.34(a)(4). These presumptions may be rebutted with sufficient evidence that a creditor did not engage in a pattern or practice of disregarding repayment ability. These presumptions are also not exhaustive. That is, a creditor may violate § 226.34(a)(4) by patterns or practices other than those specified in § 226.34(a)(4)(i). *Paragraph 34(a)(4)(i)(A)* . 1. *Failure to verify income and assets relied on* . A creditor is presumed to have violated the prohibition on lending without regard to repayment ability if the creditor has engaged in a pattern or practice of failing to verify and document repayment ability. A pattern or practice of failing to document and verify income and assets relied on to make the credit decision as required by § 226.35(b)(2)(i) would trigger this presumption. 2. *Failure to verify obligations* . A pattern or practice of failing to verify obligations would also trigger this presumption. In general, a credit report may be used to verify obligations. Where two different creditors are extending loans simultaneously, one a first-lien loan and the other a subordinate-lien loan, each creditor is expected to verify the obligation the consumer is undertaking with the other creditor. A pattern or practice of failing to do so would create a presumption of a violation. *Paragraph 34(a)(4)(i)(B)* . 1. *Variable rate loans* . For some variable rate loans, the initial interest rate is not based on the index and margin or formula used for later adjustments. In such cases, a pattern or practice of failing to consider the consumer's ability to make loan payments based on the index and margin or formula used for later adjustments, or the initial interest rate, if greater than the sum of the index and margin at consummation, would lead to a presumption that the creditor has violated § 226.34(a)(4)(i)(B). For examples of these and other variable rate loans, see comment 17(c)(1)-10. *Paragraph 34(a)(4)(i)(D)* . 1. *Failure to consider debt-to-income ratio* . A creditor is presumed to have violated the prohibition against lending without regard to repayment ability if the creditor has engaged in a pattern or practice of failing to consider the ratio of consumers' total debt obligations to consumers' income. For this purpose, a creditor may rely on the commentary to § 226.32(d)(7)(iii) to determine the components of debt and income. Unlike § 226.32(d)(7)(iii), however, § 226.34(a)(4)(i)(D) does not identify a specific debt to income ratio. Although a pattern of unusually high ratios may be evidence that a creditor has violated § 226.34(a)(4), compliance is determined on the basis of all the facts and circumstances relevant to repayment ability. *Paragraph 34(a)(4)(i)(E)* . 1. *Failure to consider residual income* . A creditor is presumed to have violated the prohibition against lending without regard to repayment ability if the creditor has engaged in a pattern or practice of failing to consider consumers' residual income. Paragraph (a)(4)(i)(E) requires a creditor to consider whether consumers will have sufficient income, after paying the new obligation and existing obligations, to cover ordinary living expenses.◂ ▸Section 226.35—Acts or Practices in Connection With Higher-priced Mortgage Loans *35(a) Coverage* . 1. *In general* . To determine whether a loan is a higher-priced mortgage loan for purposes of the limitations set forth in this section, a creditor must use the rules for determining the applicable Treasury security set forth in § 226.35(a). (Note: these rules are different from the rules in § 226.32(a).) 2. *Treasury securities* . To determine the yield on comparable Treasury securities, creditors may use the yield on actively traded issues adjusted to constant maturities published in the Board's “Selected Interest Rates” (statistical release H-15). Further guidance can be found in comments 35(a)(2)-1 and 35(a)(3)-1. *Paragraph 35(a)(2)* . 1. *In general* . Section 226.35(a)(2) sets forth the rules for identifying comparable Treasury securities for variable rate transactions. A variable rate transaction is one in which the annual percentage rate may increase after consummation. (See comment 226.18(f)-1. See also comments 226.17(c)(1)-8 and -10 for guidance on calculating the annual percentage rate for a variable rate transaction.) The rules in § 226.35(a)(2) apply to all variable rate transactions, regardless of whether the initial rate is a discounted or premium rate, or is determined by the index and margin used to make later adjustments. If the initial interest rate is fixed for more than one year, § 226.35(a)(2) requires the creditor to use the yield on the Treasury security matching the duration of the initial interest rate. For example— i. In the case of a variable rate loan with an initial interest rate fixed for the first five years based on the value of the index at consummation plus the margin, and adjusting thereafter, a creditor would use the yield on the constant maturity of five years, such as published in the statistical release H-15; ii. In the case of a variable rate loan with an initial interest rate that is a discounted or premium rate for the first five years and adjusts thereafter based on an index and margin, a creditor would use the yield on the constant maturity of five years published in the statistical release H-15; iii. In the case of a variable rate loan, if the initial interest rate is fixed for the first four years (either at the value of the index at consummation plus margin or at a discounted or premium rate), and the statistical release H-15 does not report a constant maturity of four years but reports a maturity of three years and a maturity of five years, the creditor may use the yield from either maturity; and iv. In the case of a variable rate loan, if the interest rate will adjust within the first year, the creditor would use the yield on the constant maturity of one year regardless of the length of any initial rate. For example, if the initial interest rate is fixed for one month and adjusts monthly thereafter, the creditor would use the yield on the constant maturity of one year. *Paragraph 35(a)(3)* . 1. *In general* . Section 226.35(a)(3) sets forth the rules for identifying yields on comparable Treasury securities for transactions other than variable rate transactions. Under these rules, for a transaction with a term of 30 years, the creditor would compare the APR to the yield on the constant Treasury maturity of ten years on statistical release H-15. For a transaction with a term of 15 years, the creditor would use the yield on the constant Treasury maturity of seven years. For a transaction with a term of five years, the creditor would use the yield on the constant Treasury maturity of five years. 2. *Balloon loans* . A creditor must look to the term of the loan regardless of the amortization period of the loan. For example, if a creditor extends a five-year “balloon” loan with payments based on a 30-year amortization, the creditor should use the yield on the constant Treasury maturity of five years. *Paragraph 35(a)(4)* . 1. *Application date* . An application is deemed received when it reaches the creditor in any of the ways applications are normally transmitted. See comment 226.19(a)(1)-3. An application transmitted through an intermediary agent or broker is received when it reaches the creditor, rather than when it reaches the agent or broker. See comment 19(b)-3 to determine whether a transaction involves an intermediary agent or broker. 2. *When 15th of the month is not a business day* . If the most recent 15th of the month is not a business day, the creditor must use the yield on the constant Treasury maturity as of the business day immediately preceding the 15th. *Paragraph 35(b)(2)* . 1. *Income and assets relied on* . A creditor must comply with § 226.35(b)(2)(i) with respect to the income and assets relied on in evaluating the creditworthiness of consumers. For example, if a consumer earns both a salary and an annual bonus, but the creditor only relies on the applicant's salary to evaluate creditworthiness, the creditor need only comply with § 226.35(b)(2)(i) with respect to the salary. 2. *Income and assets—co-applicant* . If two persons jointly apply for credit and both list income or assets on the application, the creditor must comply with § 226.35(b)(2) with respect to both applicants unless the creditor only relies on the income or assets of one of the applicants. 3. *Income and assets—guarantors* . A creditor does not need to comply with § 226.35(b)(2) with respect to the income or assets of a person who is not primarily liable on the obligation, such as a guarantor. 4. *Expected income* . A creditor may rely on a consumer's expected income, except equity income that would be realized from collateral, so long as the creditor verifies the basis for that expectation using documents listed under § 226.35(b)(2)(i), including third-party documents that provide reasonably reliable evidence of the borrower's expected income. For example, if, based on a consumer's statement, the creditor relies on an expectation that a consumer will receive an annual bonus, the creditor may verify the basis for that expectation with documents that show the consumer's past annual bonuses. Similarly, if the creditor relies on a consumer's expected salary following the consumer's receipt of an educational degree, the creditor may verify that expectation with a written statement from an employer indicating that the consumer will be employed upon graduation and the salary. *Paragraph 35(b)(2)(i)* . 1. *Internal Revenue Service
(IRS)Form W-2* . A creditor may verify a consumer's income using an IRS Form W-2 (or any subsequent revisions or similar IRS Forms used for reporting wages and tax withholding). The lender may also use an electronic retrieval service for obtaining the consumer's W-2 information. 2. *Tax returns* . A creditor may verify a consumer's income or assets using the consumer's tax return. A creditor may also use IRS Form 4506 “Request for Copy of Tax Return,” Form 4506-T “Request for Transcript of Tax Return,” or Form 8821 “Tax Information Authorization” (or any subsequent revisions or similar IRS Forms appropriate for obtaining tax return information directly from the IRS) to verify the consumer's income or assets. The lender may also use an electronic retrieval service for obtaining tax return information. 3. *Other third-party documents that provide reasonably reliable evidence of consumer's income or assets* . Creditors may verify income and assets using other documents produced by third parties that provide reasonably reliable evidence of the consumer's income or assets. For example, creditors may verify the consumer's income using receipts from a check-cashing service, or by obtaining a written statement from the consumer's employer that states the consumer's income. 4. *Duplicative collection of documentation* . A creditor that has made a loan to a consumer and is refinancing or extending new credit to the same consumer need not collect from the consumer a document the creditor previously examined if that document presumably will not have changed since it was initially collected. For example, if the creditor has collected the consumer's 2006 tax return to make a loan in May 2007, the creditor may rely on the 2006 tax return if the creditor makes another loan to the same consumer in August 2007. Using the same example, if the creditor has collected the consumer's bank statement for May 2007 in making the first loan, the creditor may rely on that bank statement for that month in making the subsequent loan in August. *Paragraph 35(b)(2)(ii).* 1. *No violation if income or assets relied on were not materially greater than verifiable amounts* . A creditor must verify amounts of income or assets relied upon in extending credit for a higher-priced mortgage loan. However, the creditor does not violate § 226.35(b)(2) if it demonstrates that the income or assets relied upon were not materially greater than the amounts that the creditor would have been able to verify pursuant to § 226.35(b)(2)(i) at consummation. For example, if a creditor approves an extension of credit relying on a consumer's annual income of $40,000 but fails to obtain documentation of that amount before extending the credit, the creditor will not have violated this section if the creditor later obtains evidence that would satisfy § 226.35(b)(2)(i), such as tax return information, showing that the consumer had an annual income of at least $40,000 at the time the loan was consummated.◂ ▸Section 226.36—Prohibited Acts or Practices in Connection with Credit Secured by a Consumer's Principal Dwelling *36(a) Creditor payments to mortgage brokers* . *Paragraph 36(a)(1)* . 1. *Timing of agreement* . The agreement under § 226.36(a)(1) must be entered into by the consumer and mortgage broker before the consumer pays a fee to any person or submits a written application for the credit transaction to the broker, whichever occurs first. The agreement must be entered into before the consumer's payment of any fee, regardless of whether the fee is received or retained by the broker. The agreement also must be entered into before the consumer submits a written application for the credit transaction to the broker. 2. *Written agreement* . The agreement under § 226.36(a)(1) must be in writing and must be a legally enforceable contract under applicable law. As evidence of compliance with this section, a creditor may rely on a written agreement that meets the criteria set forth in § 226.36(a)(1)(i)-(iii) and is signed and contemporaneously dated by the consumer and the broker, together with documentation (such as the HUD-1 Settlement Statement prepared in accordance with RESPA) that the creditor's payment to a broker does not exceed the amount provided for in the written agreement, taking into account any portion of that amount received by the broker directly from the consumer or out of loan proceeds. 3. *Clear and conspicuous* . The three statements required by § 226.36(a)(1)(i)-(iii) are clear and conspicuous if they are noticeable, grouped together, and prominently placed on the first page of the written agreement. They are noticeable if they are at least as large as the largest type size used in the rest of the agreement's text. This standard also requires that the statements be reasonably understandable. The following example would be considered reasonably understandable: “The total fee I/we will receive for your loan is $ ___. You will pay this entire amount. The lender will increase your interest rate if the lender pays any part of this amount. A lender payment to a mortgage broker can influence which loan products and terms the broker offers you, which may not be in your best interest or may be less favorable than you otherwise could obtain.” *Paragraph 36(a)(1)(i)* . 1. *Total amount of broker's compensation* . The agreement must set forth the total compensation the mortgage broker will receive and retain as a dollar amount. The broker's total compensation stated in the agreement is limited to amounts that the broker both receives and retains. It does not include amounts received by the broker and paid to third parties for other services obtained in connection with the transaction, such as a fee for an appraisal or inspection, provided such amounts actually are paid to and retained by third parties. *Paragraph 36(a)(2)* . 1. *Effect of section* . Section 226.36(a)(2) provides two exceptions to the general rule in § 226.36(a)(1). Creditor payments to mortgage brokers that qualify for either exception are not subject to the prohibition on creditor payments to mortgage brokers. Accordingly, in such cases, the agreement prescribed by § 226.36(a)(1) is not required. *Paragraph 36(a)(2)(i)* . 1. *State statute or regulation* . A state statute or regulation may impose a specific duty on mortgage brokers, under which a broker may not offer loan products or terms that are less favorable than the consumer otherwise could obtain through the same broker, assuming the same loan terms and conditions. For example, such a law may impose a duty on brokers to act solely in the consumer's best interests. Where brokers are subject by law to such a duty, and the applicable statute or regulation requires brokers to provide consumers with a written agreement that describes the broker's role and relationship to the consumer, § 226.36(a)(1) does not apply. *Paragraph 36(a)(2)(ii)* . 1. *Compensation not determined by reference to interest rate* . Where a creditor can demonstrate that the compensation it pays to a mortgage broker is not based on the interest rate for the transaction, § 226.36(a)(1) does not apply. This exception would be available, for example, if a creditor can show that it pays brokers the same flat fee for all transactions, regardless of the interest rate. Under this exception, unlike the general rule of § 226.36(a)(1), no part of the broker's compensation may be based on the interest rate, even if the consumer is aware of the relationship and agrees to it. Creditor payments to brokers may vary, however, based on factors other than the interest rate (such as loan principal amount) without losing this exception. *36(b) Misrepresentation of value of consumer's principal dwelling* . *36(b)(2) When extension of credit prohibited* . 1. *Reasonable diligence* . A creditor will be deemed to have acted with reasonable diligence under § 226.36(b)(2) if the creditor extends credit based on an appraisal other than the one subject to the restriction in § 226.36(b)(2). *36(c) Mortgage broker defined* . 1. *Meaning of mortgage broker* . Section 226.36(c) provides that a mortgage broker is any person who for compensation or other monetary gain arranges, negotiates, or otherwise obtains an extension of consumer credit, but is not an employee of a creditor. In addition, this definition expressly includes any person that satisfies this definition but makes use of “table funding.” Table funding occurs when a transaction is consummated with the debt obligation initially payable by its terms to one person, but another person provides the funds for the transaction at consummation and receives an immediate assignment of the note, loan contract, or other evidence of the debt obligation. Although § 226.2(a)(17)(1)(B) provides that a person to whom a debt obligation is initially payable on its face generally is a creditor, § 226.36(c) provides that, solely for the purposes of § 226.36, such a person is considered a mortgage broker. In addition, although consumers themselves often arrange, negotiate, or otherwise obtain extensions of consumer credit on their own behalf, they do not do so for compensation or other monetary gain and, therefore, are not mortgage brokers under this section. *36(d) Servicing practices* . *Paragraph 36(d)(1)(i)* . 1. *Crediting of payments* . Under § 226.36(d)(1)(i), a mortgage servicer must credit a payment to a consumer's loan account as of the date of receipt. This does not require that a mortgage servicer post the payment to the consumer's loan account on a particular date; the servicer is only required to credit the payment *as of* the date of receipt. Accordingly, a servicer that receives a payment on or before its due date and does not enter the payment on its books or in its system until after the payment's due date does not violate this requirement as long as the entry does not result in the imposition of a late charge, additional interest, or similar penalty to the consumer, or in the reporting of negative information to a consumer reporting agency. 2. *Date of receipt* . The “date of receipt” is the date that the payment instrument or other means of payment reaches the mortgage servicer. For example, payment by check is received when the mortgage servicer receives it, not when the funds are collected. If the consumer elects to have payment made by a third-party payor such as a financial institution, through a preauthorized payment or telephone bill-payment arrangement, payment is received when the mortgage servicer receives the third-party payor's check or other transfer medium, such as an electronic fund transfer. *Paragraph 36(d)(1)(ii)* . 1. *Pyramiding of late fees* . The prohibition on pyramiding of late fees in this subsection should be construed consistently with the “credit practices rule” of Regulation AA, 12 CFR 227.15. *Paragraph 36(d)(1)(iii)* . 1. *Fees and charges imposed by the servicer* . The schedule of fees and charges must include any third-party fees or charges assessed on the consumer by the servicer. 2. *Provision of schedule to consumer* . The servicer may provide the schedule to the consumer in writing or it may direct the consumer to a specific website address where the schedule is located. Any such website address reference must be specific enough to inform the consumer where the schedule is located, rather than solely referring to the servicer's home page. 3. *Dollar amount of fees and charges* . The dollar amount of a fee or charge may be expressed as a flat fee or, if a flat fee is not feasible, an hourly rate or percentage. *Paragraph 36(d)(1)(iv)* . 1. *Reasonable time* . The payoff statement must be provided to the consumer, or person acting on behalf of the consumer, within a reasonable time after the request. For example, it would be reasonable under normal market conditions to provide the statement within three business days of a consumer's request. This timeframe might be extended, for example, when the market is experiencing an unusually high volume of refinancing requests. 2. *Person acting on behalf of the consumer* . For purposes of § 226.36(d)(1)(iv), a person acting on behalf of the consumer may include the consumer's representative, such as an attorney representing the individual in pre-foreclosure or bankruptcy proceedings, a non-profit consumer counseling or similar organization, or a lender with which the consumer is refinancing and which requires the payoff statement to complete the refinancing. *Paragraph 36(d)(2)* . 1. *Payment requirements* . The servicer may specify reasonable requirements for making payments in writing, such as requiring that payments be accompanied by the account number; setting a cut-off hour for payment to be received, or setting different hours for payment by mail and payments made in person; specifying that only checks or money orders should be sent by mail; specifying that payment is to be made in U.S. dollars; or specifying one particular address for receiving payments, such as a post office box. The servicer may be prohibited, however, from specifying payment by preauthorized electronic fund transfer. ( *See* section 913 of the Electronic Fund Transfer Act.) 2. *Implied guidelines for payments* . In the absence of specified requirements for making payments, payments may be made at any location where the servicer conducts business; any time during the servicer's normal business hours; and by cash, money order, draft, or other similar instrument in properly negotiable form, or by electronic fund transfer if the servicer and consumer have so agreed.▸ By order of the Board of Governors of the Federal Reserve System, December 20, 2007. Jennifer J. Johnson, Secretary of the Board. [FR Doc. E7-25058 Filed 1-8-08; 8:45 am] BILLING CODE 6210-01-P 73 6 Wednesday, January 9, 2008 Rules and Regulations Part III Environmental Protection Agency 40 CFR Part 63 National Emission Standards for Hazardous Air Pollutants: Paint Stripping and Miscellaneous Surface Coating Operations at Area Sources; Final Rule ENVIRONMENTAL PROTECTION AGENCY 40 CFR Part 63 [EPA-HQ-OAR-2005-0526; FRL-8508-6] RIN 2060-AN21 National Emission Standards for Hazardous Air Pollutants: Paint Stripping and Miscellaneous Surface Coating Operations at Area Sources AGENCY: Environmental Protection Agency (EPA). ACTION: Final rule. SUMMARY: This action promulgates national emission standards for hazardous air pollutants (NESHAP) for area sources engaged in paint stripping, surface coating of motor vehicles and mobile equipment, and miscellaneous surface coating operations. EPA has listed “Paint Stripping,” “Plastic Parts and Products (Surface Coating),” and “Autobody Refinishing Paint Shops” as area sources of hazardous air pollutants
(HAP)that contribute to the risk to public health in urban areas under the Integrated Urban Air Toxics Strategy. This final rule includes emissions standards that reflect the generally available control technology or management practices in each of these area source categories. “Plastic Parts and Products (Surface Coating)” has been renamed “Miscellaneous Surface Coating,” and “Autobody Refinishing Paint Shops” has been renamed “Motor Vehicle and Mobile Equipment Surface Coating” to more accurately reflect the scope of these source categories. DATES: This final rule is effective on January 9, 2008. The incorporation by reference of certain publications listed in this rule is approved by the Director of the Federal Register as of January 9, 2008. ADDRESSES: The EPA has established a docket for this action under Docket ID No. EPA-HQ-OAR-2005-0526. All documents in the docket are listed in the Federal Docket Management System index at *http://www.regulations.gov.* Although listed in the index, some information is not publicly available, e.g., confidential business information or other information whose disclosure is restricted by statute. Certain other material, such as copyrighted material, is not placed on the Internet and will be publicly available only in hard copy form. Publicly available docket materials are available either electronically through *www.regulations.gov* or in hard copy at the EPA Docket Center, Public Reading Room, EPA West, Room 3334, 1301 Constitution Ave., NW., Washington, DC. The Public Reading Room is open from 8:30 a.m. to 4:30 p.m., Monday through Friday, excluding legal holidays. The telephone number for the Public Reading Room is
(202)566-1744, and the telephone number for the Air Docket is
(202)566-1742. FOR FURTHER INFORMATION CONTACT: For technical information concerning the paint stripping standards, contact Mr. Warren Johnson, Office of Air Quality Planning and Standards, Sector Policies and Programs Division, Natural Resources and Commerce Group (E143-03), U.S. Environmental Protection Agency, Research Triangle Park, North Carolina 27711, telephone
(919)541-5124, or e-mail at *Johnson.warren@epa.gov.* For technical information concerning the surface coating standards, contact Ms. Kim Teal, Office of Air Quality Planning and Standards, Sector Policies and Programs Division, Natural Resources and Commerce Group (E143-03), U.S. Environmental Protection Agency, Research Triangle Park, North Carolina 27711, telephone
(919)541-5580, or e-mail at *teal.kim@epa.gov.* SUPPLEMENTARY INFORMATION: Outline The information presented in this preamble is organized as follows: I. General Information A. Does This Action Apply to Me? B. Where Can I Get a Copy of This Document? C. Judicial Review II. Background Information for Final Area Source Standards III. Summary of Final Rule A. Applicability B. Compliance Dates C. Requirements for Paint Stripping Operations D. Surface Coating Requirements E. Notifications, Recordkeeping, and Reporting IV. Summary of Changes Since Proposal A. Applicability B. Compliance Dates C. Requirements for Paint Stripping Operations D. Requirements for Surface Coating Operations E. Notifications, Recordkeeping, and Reporting V. Summary of Comments and Responses A. Applicability B. Compliance date C. Requirements for Paint Stripping Operations D. Authority to Regulate Miscellaneous Surface Coating Operations E. Basis of Surface Coating Standards F. Training Requirements G. Spray Gun Requirements H. Spray Booths I. Spray Booth Filters J. Spray Gun Washers K. Reporting, Recordkeeping, and Compliance L. Cost and Economic Impacts VI. Summary of Environmental, Energy, and Economic Impacts A. What are the air impacts? B. What are the cost impacts? C. What are the economic impacts? D. What are the non-air health, environmental, and energy impacts? VII. Statutory and Executive Order Reviews A. Executive Order 12866: Regulatory Planning and Review B. Paperwork Reduction Act C. Regulatory Flexibility Act D. Unfunded Mandates Reform Act E. Executive Order 13132: Federalism F. Executive Order 13175: Consultation and Coordination With Indian Tribal Governments G. Executive Order 13045: Protection of Children From Environmental Health and Safety Risks H. Executive Order 13211: Actions Concerning Regulations That Significantly Affect Energy Supply, Distribution, or Use I. National Technology Transfer Advancement Act J. Executive Order 12898: Federal Actions to Address Environmental Justice in Minority Populations and Low-Income Populations K. Congressional Review Act I. General Information A. Does this action apply to me? Categories and entities potentially affected by the rule are paint stripping operations using methylene chloride (MeCl)-containing paint strippers, motor vehicle and mobile equipment surface coating operations, and miscellaneous surface coating operations located at area sources. An area source is defined in the Clean Air Act
(CAA)section 112(a) as any stationary source of HAP that is not a major source, and a major source is defined as any stationary source or group of stationary sources located within a contiguous area and under common control that emits, or has the potential to emit, considering controls, in the aggregate, 10 tons per year
(tpy)or more of any single HAP or 25 tpy or more of any combination of HAP. For the purposes of this rule, paint stripping operations are those that perform paint stripping using MeCl for the removal of dried paint (including, but not limited to, paint, enamel, varnish, shellac, and lacquer) from wood, metal, plastic, and other substrates at area sources as either:
(1)an independent activity where paint stripping is the principal activity at the source, or
(2)an activity incidental to the principal activity (e.g., surface coating, inspection, maintenance, etc.) at the source. For co-located operations, EPA considers paint stripping activities that use one ton or less to be incidental to the principal activity and those using more than one ton to be performing paint stripping as a principal activity. Motor vehicle and mobile equipment surface coating operations involve the spray application of coatings at area sources to automobiles, light trucks, heavy duty trucks, buses, construction equipment, self-propelled vehicles and equipment that may be drawn and/or driven on a roadway. Miscellaneous surface coating operations are those that involve the spray application of coatings that contain compounds of chromium (Cr), lead (Pb), manganese (Mn), nickel (Ni), or cadmium (Cd), herein after referred to as target HAP, to miscellaneous parts and/or products made of metal or plastic, or combinations of metal and plastic. In general, the facilities and entities potentially affected by some or all of the rule are covered under the North American Industrial Classification System (NAICS) codes listed in the following table. However, facilities classified under other NAICS codes may be subject to the standards if they meet the applicability criteria. Category NAICS Examples of potentially regulated entities Aerospace Equipment 336413, 336414, 336415, 54171 Aircraft engines, aircraft parts, aerospace ground equipment. Automobiles and Automobile Parts 336111, 336211, 336312, 33632, 33633, 33634, 33637, 336399, 441110, 441120, 811121 Engine parts, vehicle parts and accessories, brakes, axles, etc. Motor vehicle body manufacturing and automobile assembly plants. New and used car dealers. Automotive body, paint, and interior repair and maintenance. Chemical Manufacturing and Product Preparation 325110, 325120, 325131, 325188, 325192, 325193, 325199, 325998 Petrochemicals, Industrial Gases, Inorganic Dyes and Pigments, Basic Inorganic and Organic Chemicals, Cyclic Crude and Intermediates, Ethyl Alcohol, Miscellaneous Chemical Production and Preparation. Extruded Aluminum 331316, 331524, 332321, 332323 Extruded aluminum, architectural components, coils, rod, and tubes. Government Not Applicable Government entities, besides Department of Defense, that maintain vehicles, such as school buses, police and emergency vehicles, transit buses, or highway maintenance vehicles. Heavy Equipment 33312, 333611 Tractors, earth moving machinery. Job Shops 332722, 332813, 332991, 334119, 336413, 339999 Manufacturing industries not elsewhere classified (e.g., bezels, consoles, panels, lenses). Large Trucks and Buses 33612, 336211 Large trucks and buses. Metal Buildings 332311 Prefabricated metal buildings, carports, docks, dwellings, greenhouses, panels for buildings. Metal Containers 33242, 81131, 322214, 331513 Drums, kegs, pails, shipping containers. Metal Pipe and Foundry 331111, 331513, 33121, 331221, 331511 Plate, tube, rods, nails, etc. Rail Transportation 33651, 336611, 482111 Brakes, engines, freight cars, locomotives. Recreational Vehicles and Other Transportation Equipment 321991, 3369, 331316, 336991, 336211, 336112, 336212, 336213, 336214, 336399, 336999, 33635, 56121, 8111, 56211 Mobile Homes. Motorcycles, motor homes, semi trailers, truck trailers. Miscellaneous transportation related equipment and parts. Travel trailer and camper manufacturing. Rubber-to-Metal Products 326291, 326299 Engine mounts, rubberized tank tread, harmonic balancers. Structural Steel 332311, 332312 Joists, railway bridge sections, highway bridge sections. Waste Treatment, Disposal, and Materials Recovery 562211, 562212, 562213, 562219, 562920 Hazardous Waste Treatment and Disposal, Solid Waste Landfill, Solid Waste Combustors and Incinerators, Other Nonhazardous Waste Treatment and Disposal, Materials Recovery. Other Industrial and Commercial 211112 Natural Gas Liquid Extraction. 311942 Spices and Extracts. 331311 Alumina Refining. 337214, 811420 Office furniture, except wood. Reupholstery and Furniture Repair. 325211 Plastics Material Synthetic Resins, and Nonvulcanizable Elastomers. 325510 Paint and Coating Manufacturing. 32614, 32615 Plastic foam products (e.g., pool floats, wrestling mats, life jackets). 326199 Plastic products not elsewhere classified (e.g., name plates, coin holders, storage boxes, license plate housings, cosmetic caps, cup holders). 333313 Office machines. 33422 Radio and television broadcasting and communications equipment (e.g., cellular telephones). 339111, 339112 Medical equipment and supplies. 33992 Sporting and athletic goods. 33995 Signs and advertising specialties. 336612 Boat building. 713930 Marinas, including boat repair yards. This table is not intended to be exhaustive, but rather provides a guide for readers regarding entities likely to be regulated by the rule. Many types of entities that perform stripping and/or coating that are not listed in this table would be potentially affected by the rule. Additionally, some entities that are classified under the NAICS codes in the table may not be subject if they are not performing the operations described in the applicability criteria in §§ 63.11169 and 63.11170 of the rule. To determine whether your facility, company, business, organization, etc., is subject to this action, you should examine the applicability criteria in §§ 63.11169 and 63.11170 of the rule. If you have any questions regarding the applicability of this action to a particular entity, consult the person listed in the preceding FOR FURTHER INFORMATION CONTACT section. B. Where can I get a copy of this document? In addition to being available in the docket, an electronic copy of this final action will also be available on the Worldwide Web
(WWW)through the Technology Transfer Network (TTN). A copy of this final action will be posted on the TTN's policy and guidance page for newly proposed or promulgated rules at the following address: *http://www.epa.gov/ttn/oarpg/.* The TTN provides information and technology exchange in various areas of air pollution control. C. Judicial Review Under section 307(b)(1) of the CAA, judicial review of this final rule is available only by filing a petition for review in the U.S. Court of Appeals for the District of Columbia Circuit by March 10, 2008. Under section 307(d)(7)(B) of the CAA, only an objection to the rule that was raised with reasonable specificity during the period for public comment can be raised during judicial review. Moreover, under section 307(b)(2) of the CAA, the requirements established by this final rule may not be challenged separately in any civil or criminal proceedings brought by EPA to enforce these requirements. II. Background Information for Final Area Source Standards Section 112(k)(3)(B) of the CAA requires EPA to identify at least 30 HAP, which, as the result of emissions of area sources, pose the greatest threat to public health in urban areas. Consistent with this provision, EPA identified the 30 HAP that pose the greatest potential health threat in urban areas in 1999. These HAP are referred to as the “Urban HAP” as part of the Integrated Urban Air Toxics Strategy. See 64 FR 38715, July 19, 1999. Section 112(c)(3) requires EPA to list sufficient categories or subcategories of area sources to ensure that area sources representing 90 percent of the emissions of the 30 Urban HAP are subject to regulation. EPA listed the source categories that account for 90 percent of the Urban HAP emissions in the Integrated Urban Air Toxics Strategy. 1 Sierra Club sued EPA, alleging a failure to complete standards for the area source categories listed pursuant to CAA sections 112(c)(3) and (k)(3)(B) within the time frame specified by the statute. See *Sierra Club* v. *Johnson* , No. 01-1537, (D.D.C.). On March 31, 2006, the court issued an order requiring EPA to promulgate standards under CAA section 112(d) for those area source categories listed pursuant to CAA section 112(c)(3). 1 Since its publication in the Integrated Urban Air Toxics Strategy in 1999, EPA has revised the area source category list several times. Among other things, the order as amended on October 15, 2007, requires that, by December 15, 2007, EPA complete standards for nine area source categories. On September 17, 2007, EPA proposed NESHAP for Paint Stripping and Miscellaneous Surface Coating Operations at Area Sources. The proposal covered the following three listed area source categories that were selected to meet the December 15, 2007, deadline:
(1)Paint Stripping,
(2)Plastic Parts and Products (Surface Coating), and
(3)Autobody Refinishing Paint Shops. See 72 FR 52958. This final NESHAP completes the required regulatory action for three area source categories. Under CAA section 112(d)(5), the Administrator may, in lieu of standards requiring maximum achievable control technology
(MACT)under section 112(d)(2), elect to promulgate standards or requirements for area sources “which provide for the use of generally available control technologies
(GACT)or management practices by such sources to reduce emissions of hazardous air pollutants.” As explained in the proposed NESHAP, EPA is setting standards for these area source categories pursuant to section 112(d)(5). See 72 FR 52958, September 17, 2007. III. Summary of Final Rule A. Applicability We have revised the rule since proposal to clarify the sources to which it applies. In order to clarify the applicability of the final rule and the standards that apply, §§ 63.11169 and 63.11170 of the final rule distinguish among the three separate area source categories: paint stripping, motor vehicle and mobile equipment surface coating, and miscellaneous surface coating. The rule contains separate provisions describing the requirements for each category. The final subpart does not apply to any of the following activities listed in § 63.11169:
(1)Surface coating or paint stripping performed on site at installations owned or operated by the Armed Forces of the United States (including the Coast Guard and the National Guard of any State), the National Aeronautics and Space Administration, or the National Nuclear Security Administration.
(2)Surface coating or paint stripping of military munitions, as defined in § 63.11180, manufactured by or for the Armed Forces of the United States (including the Coast Guard and the National Guard of any State) or equipment directly and exclusively used for the purposes of transporting military munitions.
(3)Surface coating or paint stripping performed by individuals on their personal vehicles, possessions, or property, either as a hobby or for maintenance of their personal vehicles, possessions, or property. This subpart also does not apply when these operations are performed by individuals for others without compensation. An individual who spray applies surface coating of more than two motor vehicles or pieces of mobile equipment per year is subject to the requirements in this subpart that pertain to motor vehicle and mobile equipment surface coating regardless of whether compensation is received.
(4)Surface coating or paint stripping that meets the definition of “research and laboratory activities” in § 63.11180 of the final rule.
(5)Surface coating or paint stripping that meets the definition of “quality control activities” in § 63.11180 of the final rule.
(6)Surface coating or paint stripping that is specifically covered by another area source NESHAP. Section 63.11170 specifies the operations that are subject to the final standards. For paint stripping, the final rule applies to you if you use chemical strippers that contain MeCl to remove dried paint (including, but not limited to, paint, enamel, varnish, shellac, and lacquer) from wood, metal, plastic, and other substrates. The final rule also applies to you if you spray apply coatings to motor vehicles or mobile equipment for the purposes of finishing or refinishing, and clarifies that the standards apply to all sources performing these operations using spray-applied coatings, including mobile refinishing operations, except those operations that meet the definition of facility maintenance in § 63.11180. Finally, the rule applies if you spray apply coatings that contain the target HAP to plastic or metal parts and products (other than motor vehicles and mobile equipment), except those operations that meet the definition of facility maintenance or that are surface coating of a space vehicle. If you perform miscellaneous surface coating operations, but do not use any coatings that contain the target HAP, the rule does not apply. The final rule applies to all motor vehicle and mobile equipment surface coating operations. However, if you are the owner or operator of a motor vehicle or mobile equipment surface coating operation, you may petition the Administrator for an exemption from this subpart if you can demonstrate, to the satisfaction of the Administrator, that you spray apply no coatings that contain the target HAP. Petitions must include a description of the coatings that you spray apply and your certification that you do not spray apply any coatings containing the target HAP. If circumstances change such that you intend to spray apply coatings containing the target HAP, you must submit the initial notification required by 63.11175 and comply with the requirements of this subpart. Coatings are considered to contain the target HAP if they contain any individual target HAP that is an Occupational Safety and Health Administration (OSHA)-defined carcinogen as specified in 29 CFR 1910.1200(d)(4) at a concentration greater than 0.1 percent by mass or greater than 1.0 percent by mass for any other individual target HAP. For the purpose of determining whether materials you use contain the target HAP (that is, compounds of chromium (Cr), lead (Pb), manganese (Mn), nickel (Ni), or cadmium (Cd)), you may rely on formulation data provided by the manufacturer or supplier, such as the material safety data sheet (MSDS), as long as it represents each target HAP compound in the material that is present at 0.1 percent by mass or more for OSHA-defined carcinogens and at 1.0 percent by mass or more for other target HAP compounds. The final rule also includes in § 63.11180 definitions of “administrator,” “coating,” “facility maintenance,” “quality control activities,” “research and laboratory activities,” “space vehicle,” and “spray application of coatings” related to these applicability provisions. “Administrator” means the Administrator of the U.S. Environmental Protection Agency or the State or local agency that is granted delegation for implementation of this subpart. “Coating” is defined as a material spray-applied to a substrate for decorative, protective, or functional purposes. As specified in the definition in the final rule, “coating” does not include the following materials:
(1)Decorative, protective, or functional materials that consist only of protective oils for metal, acids, bases, or any combination of these substances.
(2)Paper film or plastic film that may be pre-coated with an adhesive by the film manufacturer.
(3)Adhesives, sealants, maskants, or caulking materials.
(4)Temporary protective coatings, lubricants, or surface preparation materials.
(5)In-mold coatings that are spray-applied in the manufacture of reinforced plastic composite parts. “Facility maintenance” is defined to include architectural surface coating activities on stationary structures and process equipment. It is also defined to include the surface coating of mobile equipment in the field, such as farming or mining equipment, or mobile equipment coated at a site where it is used, such as a fork truck coated at a manufacturing facility. The definition of facility maintenance specifically excludes surface coating of motor vehicles, mobile equipment, or items that routinely leave and return to the facility, such as delivery trucks, rental equipment, or containers used to transport or deliver products to customers, such as compressed gas canisters. The surface coating of these items (e.g., courier vehicles or compressed gas canisters) that routinely leave and return to the facility will be subject to the standards. “Quality control activities” has been defined to mean surface coating or paint stripping activities that meet all of the following criteria:
(1)The activities, associated with a surface coating or paint stripping operation, to detect and correct defects in the final product through selection of limited samples from the operation, and comparison of the samples against specific performance criteria.
(2)The activities do not include the production of an intermediate or final product for sale or exchange for commercial profit; for example, parts that are surface coated or stripped are not sold.
(3)The activities are not a normal part of the miscellaneous surface coating or paint stripping operation, e.g., they do not include color matching activities performed on motor vehicles as part of collision repair activities.
(4)The activities do not involve surface coating or stripping of the tools, equipment, machinery, and structures that comprise the infrastructure of the affected facility and that are necessary for the facility to function in its intended capacity, e.g., the activities are not facility maintenance. “Research and laboratory activities” has been defined to mean surface coating or paint stripping activities whose primary purpose is to conduct research and development into new processes and products, that are performed under the close supervision of technically trained personnel and do not include the manufacture of intermediate or final products for commercial sale in commerce. Such activities are ordinarily conducted in a dedicated area of a facility (such as a dedicated room or paint booth), or in a separate facility. Research and laboratory activities include, but are not limited to the following:
(1)Activities conducted to develop more efficient production processes, including alternative paint stripping or surface coating materials or application methods, or methods for preventing or reducing adverse environmental impacts.
(2)Activities conducted at a laboratory to analyze air, soil, water, waste, or product samples for contaminants or environmental impact or to develop revised production processes to limit environmental effects. “Space Vehicle” has been defined to mean vehicles designed to travel beyond the limit of the earth's atmosphere, such as satellites, space stations, and the Space Shuttle System (including orbiter, external tanks, and solid rocket boosters). “Spray-applied coating operations” has been defined to mean coatings that are applied using a hand-held device that creates an atomized mist of coating and deposits the coating on a substrate. As specified in the definition in the final rule, the following materials or activities are not considered spray-applied coatings:
(1)Coatings applied from a hand-held device with a paint cup capacity that is equal to or less than 3.0 fluid ounces (89 cubic centimeters (cc)).
(2)Surface coating application using powder coating, hand-held, non-refillable aerosol containers, or non-atomizing application technology, including, but not limited to, paint brushes, rollers, hand wiping, flow coating, dip coating, electrodeposition coating, web coating, coil coating, touch-up markers, or marking pens.
(3)Thermal spray operations (also known as metallizing, flame spray, plasma arc spray, and electric arc spray, among other names) in which solid metallic or non-metallic material is heated to a molten or semi-molten state and propelled to the work piece or substrate by compressed air or other gas, where a bond is produced upon impact. B. Compliance Dates New sources must comply with the requirements of the final rule upon startup of operations, but no earlier than the effective date of this notice. Existing sources must comply no later than three years from the effective date of this notice. C. Requirements for Paint Stripping Operations All owners and operators of regulated sources conducting paint stripping and using MeCl-containing paint stripper must implement management practices that reduce emissions of MeCl by minimizing evaporative losses of MeCl. The MeCl management practices involve only using a MeCl-containing paint stripper when an alternative on site stripping method or material is incapable of accomplishing the work as determined by the operator. Alternative methods to reduce MeCl usage may include:
(1)Non- or low-MeCl-containing chemical strippers;
(2)Mechanical stripping;
(3)Blasting (including dry or wet media); or
(4)Thermal and cryogenic decomposition. The management practices required also include optimizing stripper application conditions, reducing exposure of stripper to the air, and practicing proper storage and disposal of materials containing MeCl. Owners and operators must also maintain records of annual usage of strippers containing MeCl. In addition to the management practices, sources that use more than one ton of MeCl per year need to develop and implement a MeCl minimization plan. This must be a written plan including criteria to evaluate the necessity of MeCl in the stripping operations and whether alternatives are feasible. It must also describe the management techniques that will be used to minimize MeCl emissions when MeCl is needed in the paint stripping operation. The MeCl minimization plan evaluation criteria involves only using a MeCl-containing paint stripper when an alternative on site stripping method or material is incapable of accomplishing the work as determined by the operator. Alternative methods to reduce MeCl usage may include:
(1)Non- or low-MeCl-containing chemical strippers;
(2)Mechanical stripping;
(3)Blasting (including dry or wet media); or
(4)Thermal and cryogenic decomposition. The management practices required to be contained in the plan include optimizing stripper application conditions, reducing exposure of stripper to the air, and practicing proper storage and disposal of materials containing MeCl. Sources are required to notify either EPA or the delegated State permit authority that they have developed a MeCl minimization plan, keep a written copy of the plan on site and post a placard or sign outlining the evaluation criteria and management techniques in each area where MeCl-containing paint stripping operations occur. They are also required to review the plan annually and update it based on the experiences of the previous year or the availability of new methods of stripping and to keep a record of the review and changes made to the plan on file. D. Requirements for Surface Coating Operations All motor vehicle and mobile equipment surface coating operations and those miscellaneous surface coating operations that spray apply coatings containing the target HAP must apply the coatings with a high volume, low pressure
(HVLP)spray gun, electrostatic spray gun, airless spray gun, air-assisted airless spray gun, or a gun demonstrated to be equal in transfer efficiency to an HVLP spray gun. All spray-applied coatings must be applied in a prep station or spray booth. For motor vehicle and mobile equipment surface coating, prep stations and spray booths that are large enough to hold a complete vehicle must have four complete side walls or curtains and a complete roof. For motor vehicle and mobile equipment subassemblies and for miscellaneous surface coating, coatings must be spray applied in a booth with a full roof and at least three walls or side curtains. Openings are allowed in the sidewalls and roof of booths used for miscellaneous surface coating to allow for parts conveyors, if needed. The exhaust from the prep station or spray booth must be fitted with filters demonstrated to achieve at least 98 percent filter efficiency of paint overspray. Additionally, surface coating sources subject to the standards are required to comply with management practices by demonstrating that:
(1)All painters that spray apply coatings have completed training in techniques to minimize paint overspray, and
(2)That no spray gun cleaning is performed by spraying solvent through the gun creating an atomized mist (i.e., spray guns are cleaned in an enclosed spray gun cleaner or by cleaning the disassembled gun parts by hand). Initial painter training will be valid for a period of five years, and refresher training must be repeated at least once every five years. Painters that completed training in the last five years before the compliance date will be able to use that training to satisfy this requirement. To comply with the painter training requirements, all spray painters at new sources must complete training no later than 180 days after hiring or 180 days from the date of this notice, whichever is later. All spray painters at existing sources must complete training no later than three years from the date of this notice or no later than 180 days after hiring, whichever is later. The initial and refresher training must address the following topics to reduce coating overspray and emissions:
(1)Spray gun equipment selection, set up, and operation, including measuring coating viscosity, selecting the proper fluid tip or nozzle, and achieving the proper spray pattern, air pressure and volume, and fluid delivery rate.
(2)Spray technique for different types of coatings to improve transfer efficiency and minimize coating usage and overspray, including maintaining the correct spray gun distance and angle to the part, using proper banding and overlap, and reducing lead and lag spraying at the beginning and end of each stroke.
(3)Routine spray booth and filter maintenance, including filter selection and installation.
(4)Environmental compliance with the requirements of this subpart. E. Notifications, Recordkeeping, and Reporting All sources must submit an initial notification to the EPA or to their State or local air pollution control agency, if the EPA has delegated authority for implementing this rule to that agency, with a copy sent to EPA, unless the EPA regional office has waived the dual reporting requirements. New sources need to submit the initial notification no later than 180 days after initial startup, or no later than 180 days after the date of this notice, whichever is later. Existing sources need to submit the initial notification no later than one year before their compliance date. For new sources, the initial notification will also serve as a notification on whether the source is in compliance. For existing sources, the initial notification must indicate whether the source is already in compliance or that it will be brought into compliance by the existing source compliance date. Additionally, all existing sources that did not state in their initial notification that they were already in compliance with the management practices and equipment requirements prescribed in the final rule must also submit a notification of compliance status. The notification of compliance status must be submitted no later than 60 days after the compliance date for existing sources. The notification of compliance status must certify that the source is in compliance with the applicable requirements for the activities being performed. The initial notification must include the following information:
(1)The name, address, phone number and e-mail address (if available) of the owner and operator.
(2)The address (physical location) of the affected source. If the source is a motor vehicle or mobile equipment surface coating operation that repairs vehicles at the customer's location, rather than at a fixed collision repair shop, the notification should state this and indicate the physical location where records are kept to demonstrate compliance.
(3)A statement that the source is subject to this standard, 40 CFR part 63, subpart HHHHHH.
(4)A brief description of the type of operation, including which types of activities are performed at the source (miscellaneous surface coating, motor vehicle and mobile equipment surface coating, or paint stripping). For surface coating operations, identify the number of spray booths and the number of painters usually employed at the operation. For paint stripping, identify the method(s) of paint stripping employed (e.g., chemical, mechanical) and the substrates stripped (e.g., wood, plastic, metal).
(5)Each paint stripping operation must indicate whether they plan to annually use more than one ton of MeCl after the compliance date. Sources are only required to submit an annual report to the EPA or to their State or local air pollution control agency if any information in the initial notification, notification of compliance status report, or in a previous annual report has changed in the previous calendar year. If an annual report is needed, it must be submitted no later than 60 days after the yearly anniversary of the compliance date. All sources must keep records sufficient to demonstrate that they are in compliance at all times. These include the following:
(1)Records that each spray painter has completed the training, with the date of the initial training and the most recent refresher training.
(2)Documentation of the filter efficiency of any spray booth exhaust filter material, such as data from the filter manufacturer.
(3)Documentation from the spray gun manufacturer that each spray gun that does not meet the definition of an HVLP spray gun, electrostatic spray gun, airless spray gun, or air-assisted airless spray gun has been demonstrated to achieve a transfer efficiency equal to one of the other allowed types of spray gun.
(4)Copies of any notifications or reports that were submitted.
(5)Records of paint strippers containing MeCl used for paint stripping operations, including the MeCl content of the paint stripper used, and annual usage.
(6)If you are a paint stripping source that annually uses more than one ton of MeCl, a record of your current MeCl minimization plan, and records of your annual review of, and updates to, your MeCl minimization plan.
(7)Records of any deviation from the requirements in the final rule, including the date and time period of the deviation, and a description of the nature of the deviation and the actions taken to correct the deviation.
(8)Records of any assessments of source compliance performed in support of the initial notification, notification of compliance status, or annual notification of changes report. Under the final rule, owners and operators will not be required to obtain a Title V operating permit under 40 CFR part 70 or 71, provided they are not required to obtain a permit for another reason, even though the source is an area source. IV. Summary of Changes Since Proposal A. Applicability We have revised the rule since proposal to clarify the scope of the source category to which it applies, and to clearly identify the sources subject to the requirements of the rule. These revisions make clear that the affected source category is not as broad as could have been interpreted based on the language of the proposed rule. These changes were made in both the applicability sections (§§ 63.11169 to 63.11171) and to the definitions in § 63.11180 that describe particular operations that are subject to the standards. We have revised § 63.11169 to specify that compounds of chromium (Cr), lead (Pb), manganese (Mn), nickel (Ni), and cadmium
(Cd)are the HAP for which the surface coating standards for miscellaneous surface coating operations category was listed and which the standards are designed to control. In subsequent sections of the rule, certain provisions apply only to surface coating operations that are sources of these target HAP. We have revised § 63.11170 to separate and more clearly explain how the rule applies to paint stripping, motor vehicle and mobile equipment surface coating, and miscellaneous surface coating. In particular, motor vehicle and mobile equipment surface coating has been separated from the larger category of miscellaneous surface coating and is treated separately in the rest of the rule. In the proposed rule, all surface coating was included under a single set of requirements that made no distinction between motor vehicle and mobile equipment surface coating and all other miscellaneous surface coating. The National Nuclear Security Administration
(NNSA)has been added to the list of installations to which this subpart does not apply. This list is found in § 63.11169. Surface coating and paint stripping at NNSA installations would be regulated by the military surface coating NESHAP that is under development. Section 63.11169 has also been revised to specify that these standards do not apply to paint stripping and surface coating performed by individuals as part of a hobby, or for maintenance of their personal vehicles, possessions, and property, or when they perform these activities for others without compensation. For motor vehicle and mobile equipment surface coating, all sources and individuals that spray finish more than two motor vehicles or pieces of mobile equipment per year are subject to the requirements in the final rule that pertain to motor vehicle and mobile equipment surface coating regardless of whether compensation is received. However, we have included a provision in the final rule that allows an owner or operator of a motor vehicle or mobile equipment surface coating operation to petition the Administrator for an exemption from this subpart if the owner or operator can demonstrate that they spray apply no coatings that contain the target HAP. Petitions must include a description of the coatings that they spray apply and certification that they do not spray apply any coatings containing the target HAP. If circumstances change such that the owner or operator intends to spray apply coatings containing the target HAP, the owner or operator must submit the initial notification required by 63.11175 and comply with the requirements of this subpart. While the proposed rule would have required all motor vehicle and mobile equipment surface coating operations to comply with the requirements of the rule, because the category was listed for the target HAP, it is appropriate to allow operations that do not use products containing the target HAP to request that the rule not apply to them based on an adequate demonstration that they do not use such products. EPA's understanding, based on site visits and communications with the industry, is that many shops, especially smaller ones, purchase coatings “over the counter” on a retail basis and usually do not receive composition data, such as a material safety data sheet (MSDS), with these coatings. In addition, when a specific color is needed for refinishing a vehicle, it is usually custom-mixed from any number of about 50 different toners, either by the painter at the shop, or by the coating retailer. Therefore, it will likely be very difficult to determine whether any particular coating being sprayed contains the target HAP, unless the HAP composition of all coatings within the shop is known. For this reason, and because we received comments from industry supporting the proposed requirements, we expect that few, if any, petitions will be received. We hope to encourage reformulation where possible through this provision. The applicability language in § 63.11169 in the final rule has been revised to exclude paint stripping and surface coating that meets the definition of research and laboratory activities, and quality control activities, as defined in § 63.11180. The applicability language in § 63.11170 for motor vehicle and mobile equipment surface coating operations has been revised to clarify that the standards apply to all sources that spray apply these coatings, including mobile refinishing operations, except when they qualify as facility maintenance, as defined in § 63.11180. The applicability language for miscellaneous surface coating operations has been revised to clarify the scope of the source category subject to regulation. First, the standards apply to the spray application of only coatings that contain the target HAP at miscellaneous surface coating operations. Second, language has been added to clarify that the standards apply only to plastic and metal substrates. Third, the rule has been revised to also exclude miscellaneous surface coating that meets the definition of “facility maintenance.” Finally, surface coating on space vehicles has been specifically excluded so as to parallel the applicability of subpart GG, the major source NESHAP for Aerospace Manufacturing and Rework Facilities. The applicability of the final rule has been further clarified by revising or adding definitions to § 63.11180 that better explain the operations that are covered. The definition of “coating” was revised to clarify that the following are not coatings subject to this rule:
(a)Adhesives, sealants, maskants, or caulking materials.
(b)Temporary protective coatings, lubricants, or surface preparation materials.
(c)In-mold coatings that are spray-applied in the manufacture of reinforced plastic composite parts. New definitions were added for “facility maintenance”, “quality control activities”, “research and laboratory activities”, and “spray-applied coating.” These definitions were fully described in section III.A of this preamble. B. Compliance Dates The compliance date for existing sources has been extended from two years to three years after the effective date of today's final rule notice. C. Requirements for Paint Stripping Operations The format of the MeCl minimization plan threshold for the paint stripping portion of the rule has been revised from total stripper volume usage to MeCl mass usage for several reasons. First, EPA believes it is more appropriate to address the emissions directly, when possible, in lieu of using a surrogate that may or may not accomplish the goal. Additionally, a mass usage format may serve as an incentive for sources to evaluate the appropriate MeCl content of their chemical strippers and also provide the sources with greater flexibility. The rule sets the MeCl minimization plan threshold at one ton per year of MeCl contained in paint strippers. D. Requirements for Surface Coating Operations The rule has been revised to create separate categories for motor vehicle and mobile equipment surface coating and for miscellaneous surface coating. For motor vehicle and mobile equipment surface coating, the requirements for painter training, high efficiency spray guns (e.g., HVLP or equivalent), spray booths with filters, and gun washing still apply to all sources as described in the applicability section of the rule. For miscellaneous surface coating operations, the rule has been revised so that it applies only to those surface coating operations that spray apply coatings that contain the target HAP; other surface coating operations do not need to comply with those requirements. Miscellaneous surface coating operations that spray apply coatings that contain the target HAP must meet the same requirements as motor vehicle and mobile equipment surface coating operations. The spray painter training requirements have been revised so that training is not required on those topics that do not have a direct effect on emissions reductions. More detail has been added on the topics that impact emissions reductions (e.g., transfer efficiency) and for which training is required. The training requirements have also been revised to allow an owner or operator to certify that their employees have completed training to facilitate the use of in-house training programs. Spray painters will also have 180 days to complete training after hiring or transferring to a surface coating job, instead of 60 days. The requirements for spray guns have been revised to allow the use of airless or air-assisted airless spray guns without having to demonstrate that they are equivalent to HVLP spray guns in transfer efficiency. The requirements for spray booth filters have been revised so that all spray booth exhaust filters must achieve 98 percent paint overspray filter efficiency (also referred to as “arrestance”), and details have been added on the method that must be used to measure that efficiency. The final rule also clarifies that compliance with the filter efficiency standard can be demonstrated through data provided by the filter manufacturer. The booth requirements have been revised to allow for openings in side walls and roofs for part conveyors. They have also been revised to allow for booths that are operated at up to 0.05 inches water gauge positive pressure, if they have sealed doors and other openings and use a pressure balancing system. The rule language related to spray gun washing has been revised to clarify that atomized spraying of gun cleaning solvent is prohibited, and allowable means of washing spray guns include hand cleaning disassembled spray guns, manually flushing solvent through the gun (without atomizing it) and capturing the spent solvent, and using an enclosed gun washer, but an enclosed gun washer is not required. E. Notifications, Recordkeeping, and Reporting The notification and reporting requirements of the rule have been simplified and reduced. All sources will still need to submit an initial notification, but in that initial notification, sources will be asked to state whether they are already in compliance with the requirements of the rule or whether they plan to be in compliance by the compliance date. For new sources, the initial notification will also serve as the notification of compliance status since they would otherwise be due by the same date. If existing sources are already in compliance by the time they submit the initial notification and certify that they are in compliance in their initial notification, they do not need to submit a separate notification of compliance status. The need for regular annual compliance reports has also been removed. Sources will need to submit an annual compliance report only if there is a change in any of the information contained in the initial notification, the notification of compliance status (if one was needed), or in a previous annual compliance report (if one was needed). The rule has been revised to remove the requirement for paint stripping sources to submit MeCl minimization plans to permitting authorities. Facilities will be required to submit either an initial notification or a notification of compliance status that says they have prepared and implemented the plan. Instead of submitting the plan, sources are only required to keep the plan on site. The facility has to review and update their plan annually and keep records of the review and changes made on site rather than submitting an annual compliance report to EPA or a State permitting authority. For paint stripping, motor vehicle and mobile equipment surface coating operations, and miscellaneous surface coating operations, the rule has been revised so that these sources will only have to keep the records needed to demonstrate compliance instead of submitting annual compliance reports. V. Summary of Comments and Responses A. Applicability *Comment:* Several commenters argued that the miscellaneous surface coating rule should apply only to surface coating facilities that emit the target HAP, and that target HAP should be defined as the HAP for which the miscellaneous surface coating source category was listed. These are specifically compounds of Cr, Pb, Mn, Ni, and Cd. *Response:* The EPA agrees with the commenters and recognizes that many miscellaneous surface coating operations exist that do not spray apply coatings containing the target HAP. Therefore, the applicability sections have been revised so that the final rule will apply to only miscellaneous surface coating sources that spray apply coatings containing the target HAP. If your miscellaneous surface coating operations do not spray apply any coatings containing the target HAP, then you are not subject to this rule and do not need to comply with the requirements for operator training, spray guns, or spray booths. This change in the language of the applicability provision accurately reflects the sources for which the miscellaneous surface coating source category was listed, because sources that do not spray apply coatings containing the target HAP will have no target HAP emissions and were therefore not part of the inventory on which the source category listing was based. It will also create an incentive for all miscellaneous surface coating sources to review the coatings they are spray applying and find substitutes for those that contain the target HAP or to switch to non-spray methods to apply those coatings. Although some contract coaters and “job shops” may use a large number of different coatings, most miscellaneous surface coating operations use only a small number of coatings and the composition data for these can be reviewed to identify whether these coatings contain the target HAP. However, based on the overwhelming support of the commenters for the applicability criteria and scope of the motor vehicle and mobile equipment source category, we are not narrowing the applicability to only the target HAP for the motor vehicle and mobile equipment source category. The EPA's understanding, based on site visits and communications with the industry, is that these requirements are consistent with current good environmental and worker protection practices. (See other comment responses for additional clarifications on applicability that exclude coating of personal property and vehicles, facility maintenance coating, etc.) The final rule applies to all motor vehicle and mobile equipment surface coating operations. However, if you are the owner or operator of a motor vehicle or mobile equipment surface coating operation, you may petition the Administrator for an exemption from this subpart if you can demonstrate, to the satisfaction of the Administrator, that you spray apply no coatings that contain the target HAP. Petitions must include a description of the coatings that you spray apply and your certification that you do not spray apply any coatings containing the target HAP. If circumstances change such that you intend to spray apply coatings containing the target HAP, you must submit the initial notification required by 63.11175 and comply with the requirements of this subpart. *Comment:* One commenter suggested that the rule should be revised to add the NNSA to the list of installations to which this subpart does not apply. The commenter noted that EPA is planning that surface coating and paint stripping at NNSA installations would be addressed by the military surface coating NESHAP that is under development. *Response:* The EPA agrees and has added NNSA installations to the list of installations to which this subpart does not apply. These installations will be addressed by the military surface coating NESHAP that is under development. *Comment:* Several comments noted that the applicability of the proposed rule, as written, could be interpreted to apply to all paint stripping and surface coating operations, and included no exemptions for automobile hobbyists or homeowners stripping and painting their own property or vehicles. Nearly all commenters felt that paint stripping and surface coating by hobbyists and homeowners should be exempt from the rule. Several commenters suggested that EPA establish a de minimis usage threshold, based on either major source surface coating rules or state volatile organic compounds
(VOC)rules, to exclude noncommercial paint stripping or surface coating operations. The commenters noted that hobbyist and homeowner activities are difficult to locate because they are located in residential areas and are intermittent. However, one commenter suggested that the rule should have no exemptions and any individual painting vehicles should be subject to the proposed equipment and training requirements. *Response:* EPA re-examined the scope of the source categories that we listed based on the 1990 national emissions inventory. The analyses that were the basis for the source category listing for paint stripping, miscellaneous surface coating, and motor vehicle and mobile equipment surface coating focused on commercial operations, along with some government and institutional operations, such as municipal garages that service fleet vehicles. Homeowners and hobbyists were not part of these analyses and were not intended to be part of the listed source categories. Therefore, the final rule has been revised to clarify that it does not cover paint stripping and surface coating performed by individuals on their personal vehicles, possessions, or property, either as a hobby or for maintenance. This subpart also does not apply when these operations are performed by individuals for others without compensation, which is akin to the hobbyist and homeowner activities not considered in the baseline inventory that formed the basis for the listing of the source categories at issue here. However, for motor vehicle and mobile equipment surface coating operations, an individual surface coating more than two vehicles per year will be covered by the rule. This limit on the number of vehicles coated per year was included so that commercial automobile surface coating shops could not avoid compliance by claiming to be a hobby shop. The limit was based on information collected from automobile hobbyists during the rule development. The hobbyists that provided information to the EPA suggested that a legitimate hobbyist would complete no more than two automobile restorations or customizations per year. The EPA is not including a volumetric coating usage threshold in the final rule for either motor vehicle and mobile equipment surface coating operations, or for miscellaneous surface coating operations, as suggested by some commenters, because the threshold is not supported by the baseline inventory on which we based our listing decision. CAA section 112(c)(3) requires that EPA list sufficient categories and subcategories to ensure that area sources representing 90 percent of the emissions of the 30 listed urban HAP are subject to regulation. The CAA contains no exemption from the statutory requirement to regulate sources accounting for 90 percent of the emissions of an urban HAP. The inventory does not indicate that in listing the categories at issue here EPA included only those sources that use coatings above a certain threshold amount. Moreover, the commenter's reliance on the use of thresholds in certain major source HAP rules and State VOC rules is misplaced. EPA listed the area source categories at issue in this rule because the categories accounted for a certain percentage of the emissions necessary to meet the 90 percent requirement for the target urban HAP; therefore, regulation of the categories as listed is necessary for EPA to attain the 90 percent reduction of those HAP and comply with the requirements of section 112(c)(3) and 112(k). The rules on which the commenters rely were not issued under these provisions. *Comment:* Three commenters suggested EPA exempt from the proposed rule operations that use less than 150 gallons per year of paint stripper that contains MeCl. A commenter justified the exemption as allowing minor paint stripping operations to continue, and let the regulating authorities focus on the more significant operations and facilities. *Response:* EPA is required by the CAA to regulate emissions from area sources, which are, by definition, small sources. Based on baseline emission estimates updated with additional information provided by commenters, we estimate that 150 gallons of MeCl equates to approximately one ton of MeCl emissions per year from each of these small sources. This represents around five percent of the total area source MeCl emissions considered in the original section 112(k) inventory. While we appreciate the opinions of the commenters to focus on the more significant emitters, we cannot justify ignoring this level of MeCl emissions. We have minimized the requirements and burden on these low level users by not requiring them to develop MeCl minimization plans. We do not feel that asking them to consider alternatives to using MeCl-based strippers is overly burdensome. The reporting requirements for these low level users are also minimal. They must submit an initial notification letter and keep MeCl-based stripper purchase or use records, which we believe would be maintained for tax purposes already. We do not believe that receiving one letter per facility would be overly burdensome for permitting agencies. In conclusion, we feel that our approach has adequately balanced the requirements of the CAA without unduly burdening small businesses in this source category or permitting agencies. *Comment:* One commenter noted that while basing the threshold level that triggers development of a written MeCl minimization plan on the total quantity of stripper used may simplify compliance, it does not consider the MeCl content of the stripper formulation, and thus may create a disincentive for facilities to explore formulations with lower MeCl content. They stated that, although the MeCl-based products commonly used in paint stripping operations contain 75 to 90 percent MeCl, products containing 40 to 50 percent of the solvent are also available. However, they pointed out that facilities may need to use more stripper to compensate for the lower MeCl content, resulting in the need for higher volumes. The commenter indicated that they did not believe that specifying a use threshold based on the MeCl content was appropriate. They indicated that a higher gallon-per-year limit would allow many paint stripping firms to explore the applicability of lower MeCl-content formulations to their operations. The commenter stated that discussions with member companies that formulate MeCl-based strippers for commercial operations indicated that a threshold of 500 to 600 gallons also would better distinguish between operations that perform paint stripping as a regular part of their business and those that conduct stripping on an as-needed (incidental) basis. Another commenter said that to be cost effective, shops buy MeCl based strippers in 55 gallon drums, which makes the 150 gallon per year minimum unrealistic. They suggested that a 220 gallon per year threshold would be a more realistic number and would reflect a factor of cost-effective bulk purchases. *Response:* As discussed in the proposal preamble (72 FR 52966), a subcategory of paint strippers was created to distinguish those sources that were assumed to have alternative on site paint stripping technologies available. The threshold level to define this subcategory was proposed as a volume of MeCl-based stripper used (150 gallons per year). Given the large number of small businesses that will be impacted by this rule, we thought that this volume-based threshold would lessen the burden when compared with a threshold based on the mass of MeCl in the stripper. However, we do recognize the relevant points made by the commenter. If owners and operators performing paint stripping cannot find non-MeCl alternatives, we certainly want to encourage them to consider strippers with lower MeCl contents. We understand that basing this threshold on volume may provide a disincentive to the use of these low-MeCl content strippers. Like the commenter, we do not believe that specifying a use threshold based on the MeCl content is appropriate. However, we believe that simply raising the volume-based threshold would remove all incentive to use lower MeCl content strippers, rather than encourage their usage. Increasing the volume-based threshold from the proposed 150 gallons per year to the suggested 500 to 600 gallons per year would increase the emissions of facilities required to develop a written MeCl minimization plan three or four-fold, assuming that they utilize a stripper with the same MeCl content. Further, sources using these levels of MeCl strippers could emit as much as three to four tons of MeCl if using high-MeCl content strippers. We do not believe it is unreasonable to require sources with the potential to emit MeCl at these levels to develop a formal plan for reducing these emissions and evaluating the feasibility of alternative paint stripping technology. We considered including both a volume-based and mass-based threshold in the final rule. However, the complexity of such provisions defeated the purpose of using a simple volume-based threshold in the first place. Therefore, in the final rule, the threshold that defines the subcategory of paint strippers that is required to develop a written MeCl minimization plan is on a mass basis. Specifically, the final rule requires paint strippers that use more than one ton per year of MeCl in paint strippers to develop a written MeCl minimization plant to implement the management practices in the rule. As noted in the proposal preamble, a major criterion in the selection of the proposed 150 gallons per year threshold was our model plant impacts analysis. The 150 gallons per year level was selected for the model plant representing stripping operations that use between 100 and 250 gallons of MeCl paint strippers. Facilities represented by this model plant would be using around one ton of MeCl per year for their paint stripping operations, depending on the density of the stripper and the percent of MeCl in the stripper (assuming the higher range of MeCl contents confirmed by the commenter). Therefore, as described elsewhere in the record for this rulemaking, any level selected within this range would still be consistent with our proposed threshold. In addition to being consistent with our proposed intention, the one ton MeCl per year threshold is also relatively compatible with the requested volume-based levels requested by the commenter, assuming that lower-content MeCl strippers are used. For example, between 450 and 500 gallons of paint stripper containing 40 percent MeCl could be used and still remain below the one ton per year MeCl threshold. Finally, while we appreciate the practicality of a threshold based on the purchase of 55-gallon drums, as discussed above, we have concluded that any volume-based threshold is not ideal. If owners and operators of paint stripping operators wish to remain below the threshold and avoid the requirement to develop a written MeCl minimization plan, we would suggest that they calculate the number of 55-gallon drums of stripper that they can utilize and still remain below the one ton level and plan accordingly. *Comment:* Two commenters felt the number of affected paint stripping sources used to assess impacts in the proposed rule was too low. A commenter extrapolated information from California, Canada, and other sources to develop an estimate of sources affected by the proposed rule and commented that EPA's estimate of 3,000 sources was an underestimate. Using two methods to extrapolate from estimates of furniture stripping operations using MeCl-based strippers in California, one based on population and the other based on business statistics, they estimated that nationally, approximately 4,000 sources were involved in furniture stripping with MeCl-based strippers. Factoring in autobody shops use of MeCl-based strippers, the number of facilities affected is two to three times EPA's estimate of 3,000 firms. Additionally, a significantly larger number of firms would exceed the proposed 150 gallon threshold. As a result, the total cost of EPA's proposal would be significantly higher than estimated. *Response:* Developing an estimate of the number of affected sources was a difficult portion of the analyses conducted, to arrive at the proposed rule and to estimate its impacts. Unlike source categories with large facilities, emission inventories were not as useful in arriving at an estimate of facility numbers. Further, this source category does not have an industrial trade organization to turn to for further information about the source category. We appreciate the additional information on number of affected facilities provided by the commenters and considered the impacts of revising the population in the final rule. However, since little documentation was provided in support of the population estimate we have decided not to revise the estimate of sources. Finally, a change in the population totals affects the impacts proportionally and since we received no adverse comments on the assumptions and basis for our proposed impacts, which indicated a cost savings, we have decided not to revise the impacts and just rely on those at proposal as a worst-case analysis. *Comment:* Several commenters asked for clarification on whether the rule applies to mobile automobile refinishers that perform spot repairs and other refinishing, such as fender and bumper repairs, at the customer's location, rather than in a conventional collision repair shop. Several other commenters also asked for clarification on whether motor vehicle refinishing coating operations (primarily refinishing of car bumpers and fenders) using “miniature” spray guns would be subject to the same standards as other motor vehicle refinishing operations. The commenters felt that surface coating with these miniature spray guns should be subject to the proposed standards, but felt that the final rule should clarify this applicability relative to operations done with air brushes. One commenter asked the EPA to increase the size of the spray cup allowed on air brushes that would be exempt from the standards. *Response:* The proposed and final rule is intended to cover mobile motor vehicle refinishing operations that bring the coating equipment and supplies to the repaired vehicle, as well as those in which the vehicle is brought to a conventional collision repair shop. In the final rule, these mobile refinishers are subject to the rule requirements for training, spray equipment, and the use of a spray booth or other ventilated and filtered enclosure if they spray apply coatings from a spray gun with a cup size greater than 3.0 fluid ounces (89 cc). If they use a cup size equal to or smaller than 3.0 fluid ounces, they do not need to comply with the requirements for training, spray guns, and ventilated and filtered enclosures. The proposed rule would not have applied to spray-applied coatings using an airbrush or spray gun with a cup size of 1.0 fluid ounce (30 cc) or less, and this was intended, in part, to address mobile repair and refinishing operations that performed repairs of small stone chips and scratches, and graphic artists and others using these small spray guns to paint motor vehicles, signs, or other items that are potentially subject to the rule. These touch up and repair operations, and graphic arts painting on vehicles, were not part of the original inventory that focused on collision repair shops and other types of motor vehicle and mobile equipment surface coating, so the source category does not include surface coating with small airbrushes, and such operations are not subject to this rule. However, during the development of this rule, the EPA learned that more motor vehicle and mobile equipment surface coating that was formerly done by collision repair shops (and as such, was reflected in the source category listing) is now being done by mobile operators. Since this practice is becoming more common, the EPA has decided that this source of emissions should be regulated on the same basis as motor vehicle and mobile equipment surface coating that takes place at a fixed location. Even so, the EPA felt it was not necessary to regulate in this rule small touch up and spot repair operations done with an airbrush, because these operations were not reflected in the original inventory and source category listing. Since the EPA could identify no single characteristic or group of characteristics to clearly differentiate a larger spray gun from an “air brush” we have decided to define applicability based on the cup size of the spray equipment. In the final rule, all motor vehicle and mobile equipment spray coating operations and miscellaneous surface coating operations with a cup size greater than 3.0 ounces (89 cc) would be subject to the applicable standards for painter training and equipment. Surface coating operations with a smaller cup size would not be subject to the standards for spray-applied surface coating operations since these are typically just touch up and repair surface coating. This size (3.0 ounces or 89 cc) was selected based on a review of vendor literature for miniature spray guns and air brushes, and discussions with collision repair shop owners that commented on the proposed rule. This cup size is less than the minimum practical amount of coating that could be used to refinish a bumper or fender. Therefore, it helps distinguish those sources that are doing small scratch and spot repairs from those that are doing work that is more typically done at a collision repair shop. *Comment:* Many commenters stated that the proposed requirements for miscellaneous surface coating operations, as written, could be interpreted to potentially apply to all surface coating operations beyond those associated with the manufacture of plastic and metal parts and products. Examples cited by the commenters included the spray application of adhesives that do not include any of the target HAP, the spray application of coatings in the manufacture of leather shoes, and the spray application of coatings in the restoration of wood furniture. Several commenters also asked that the rule should specifically exclude surface coating operations that do not involve the use of spray-applied liquid coatings, since these operations have little potential for the target HAP emissions. Other commenters noted that the proposed rule could also be interpreted to apply to the surface coating of buildings and other stationary structures, such as bridges, water towers, and stationary equipment at manufacturing and processing facilities. The commenters recommended that the rule include an exemption for facility maintenance surface coating, and for research and development activities, as is found in the major source surface coating rules. Other commenters added that quality control activities should also be exempt since these are often of the same scale as research and development activities and are conducted at coating manufacturing facilities that do not produce surface coated parts for sale. Some commenters noted that it may be impractical to perform surface coating of large pieces of mobile equipment, such as some types of mining and farm equipment, in a spray booth or similar enclosure. The commenters suggested an exemption for these types of equipment that are generally coated in the field since it is not practical to move them to a dedicated facility for surface coating. *Response:* The EPA agrees with the commenters that the rule was intended to only apply to surface coating on plastic and metal substrates and language has been added to clarify that the standards do not apply to other substrates, such as wood, leather, fabric, rubber, masonry, ceramics, concrete, or stone. Spray coating of these other substrates was not considered in the inventory on which the surface coating source category listing was based. The rule has also been revised to specifically exclude surface coating that meets the definitions of “facility maintenance”, “research and laboratory activities”, and “quality control activities” in § 63.11180. Paint stripping and surface coating associated with these research and laboratory activities and quality control activities will not be subject to the standards as long as the items that are the subject of the surface coating or paint stripping are not products for commerce or for a function outside the facility, and do not leave the facility. For example, surface coating of test coupons in the manufacture of a coating to verify the final color of the coating is a quality control activity that is exempt from the rule because the test coupons are not products for commerce and are not intended to leave the facility. However, surface coating that is done to correct a defect or repair damage on a product that was detected as part of a final quality control check before the product leaves the factory is potentially subject to the rule. “Facility maintenance” is defined to include architectural surface coating activities on stationary structures and process equipment. It is also defined to include the surface coating of mobile equipment in the field, such as farming or mining equipment, or mobile equipment coated at a site where it is used, such as a fork truck coated at a manufacturing facility. The surface coating of stationary structures in the field was not intended to be part of the miscellaneous surface coating source category and was not included in EPA's analysis in the development of the proposed rule. Similarly, the surface coating of process equipment including, for example, farming and mining equipment that is coated in the field, was also not intended to be part of the source category and was not included in EPA's analyses. The definition of facility maintenance specifically excludes surface coating of motor vehicles, mobile equipment, or other items that routinely leave and return to the facility, such as delivery trucks, rental equipment, or containers used to transport or deliver products to customers. The paint stripping and surface coating of these latter items that routinely leave and return to the facility are subject to the standards for surface coating operations. Facility maintenance is limited to the paint stripping and surface coating of the infrastructure or process equipment of the facility. Items that routinely leave and return to a facility are not considered part of the facility's infrastructure or process equipment. The final rule includes definitions of “coating” and “spray-applied coating operations” that include lists of materials and activities that are not subject to the final standards for either motor vehicle and mobile equipment surface coating, or for miscellaneous surface coating operations. The definition of “coating” excludes the following materials because they either do not contain the target HAP, they are not spray-applied,or, if they are spray-applied, they are applied in larger particles that settle near the source and are not emitted and are not sources of the target HAP for which the surface coating categories were listed: • Decorative, protective, or functional materials that consist only of protective oils for metal, acids, bases, or any combination of these substances. • Paper film or plastic film that may be pre-coated with an adhesive by the film manufacturer. • Adhesives, sealants, maskants, or caulking materials. • Temporary protective coatings, lubricants, or surface preparation materials. The definition of “coating” also excludes in-mold coatings, typically gel coatings, that are spray-applied in the manufacture of reinforced plastic composite parts. Gel coats are part of the fabrication process for reinforced plastic composites, and were considered in separate processes when the EPA developed the inventory which served as the basis for the source category listing. The definition of “spray-applied coating operations” excludes several operations that were not considered part of the inventory that was the basis for the source category listing. These excluded operations are not subject to the rule. As described earlier in this section, coatings applied from a spray gun or air brush with a paint cup capacity that is equal to or less than 3.0 fluid ounces (89 cc) are not included because they are primarily used for touch up and repair operations. Surface coating application using powder coating, hand-held, non-refillable aerosol containers, or non-atomizing application technology, including, for example, paint brushes, rollers, hand wiping, flow coating, dip coating, electrodeposition coating, web coating, coil coating, touch-up markers, and marking pens are not included because they do not atomize coating, so they are not sources of the target HAP emissions from the spray application of coating. The definition of spray-applied surface coating operation does not include thermal spray operations (also known as metallizing, flame spray, plasma arc spray, and electric arc spray, among other names). In these operations, solid metallic or non-metallic material is heated to a molten or semi-molten state and propelled to the work piece or substrate by compressed air or other gas, where a bond is produced upon impact. These are inorganic coatings (conductive metals) that were not considered part of the source category. In addition, although they are metals (usually zinc or aluminum), they do not contain the target HAP of concern for which the miscellaneous surface coating category was listed. In addition, the metal particles created are larger than those created in spraying liquid organic coatings and are less likely to be emitted. *Comment:* One commenter asked that the applicability be revised to specifically exclude surface coating operations on space vehicles so as to parallel the applicability of subpart GG, the major source NESHAP for Aerospace Manufacturing and Rework Facilities. *Response:* The EPA agrees with the commenter and has revised § 63.11170 to specifically exclude surface coating on space vehicles from the standards for miscellaneous surface coating in the final rule. However, paint stripping operations on space vehicles using MeCl would still be subject to the standards in the final rule. Paint stripping on space vehicles is regulated at major sources by subpart GG. B. Compliance Date *Comment:* Several State agency commenters requested existing sources be given three years to comply rather than two years. They contend that more time is needed for State and local agencies to identify all subject sources and perform the needed outreach activities, and for the sources to have time to get all of their painters trained and to purchase and install any needed equipment. Sources may be difficult to identify and unfamiliarity with the rules is likely to be widespread because the sources are small businesses, with frequent employee turnover and changes in ownership. Commenters added that most other air toxics regulations allow existing sources three years to comply and this rule should be consistent to allow time for outreach. *Response:* EPA has revised the proposed rule to allow existing sources three years to comply. EPA agrees that the State agencies and other commenters have provided sufficient justification that three years is needed. There is a lack of readily available information to identify all of the area sources that are subject to the rule. Many of the area sources covered by the rule are small and have not previously been subject to air pollution control rules. Therefore, implementing agencies will need time to widely publicize these rules, develop outreach materials, and perform outreach though a variety of channels in order to inform sources that they are subject to the rule. In addition, many small sources are likely to require assistance in determining applicability, identifying the necessary steps to achieve compliance including, but not limited to locating and registering for painter training. Section 112 of the CAA allows up to three years for existing sources to comply, and given the characteristics of the source category, three years is a reasonable compliance time for this rule. C. Requirements for Paint Stripping Operations *Comment:* Two commenters provided positive feedback on the proposal of Generally Available Management Practices as GACT, agreeing that development of a MeCl minimization plan is a good idea. They added that the plan would make sources more aware of the impacts of certain practices and require them to develop alternate ways to perform paint stripping operations without the use of MeCl. Another supported the EPA's focus on management practices to reduce emissions of MeCl from paint stripping operations rather than on what they termed inappropriate technology requirements or alternative stripping techniques. *Response:* Like the commenters, we believed that it was most appropriate to place the decisions on the feasibility of alternatives to MeCl strippers at the feet of those who know their business best. Therefore, the final rule retains the proposed requirements that owners and operators institute management practices to reduce MeCl emissions from paint stripping. *Comment:* There were several comments received that discussed the need for MeCl for stripping and expressed doubt at the plausibility of alternative technologies. A commenter remarked that in many cases, products containing MeCl are the only effective means of removing certain finishes, such as polyurethanes and most paints, for commercial operations. Another stated that, in their department's experience, most chemical paint stripping operations were dedicated to stripping paint from wooden furniture. They noted that the proposed management practice of recoating without stripping or substituting alternative stripping technologies was not a possibility for painted wood. Owners of a small business dedicated to restoring furniture, commented that for furniture restoration shops to reduce their MeCl use, there would have to be better alternative chemical strippers available. MeCl strippers are not flammable, but the current alternative chemical strippers are highly flammable and explosive. In addition, the current alternative chemical strippers cost two to three times those containing MeCl, and take two to five hours to work versus 15 to 20 minutes for those containing MeCl. Another commenter supported the EPA's proposal to allow the facility to determine whether a MeCl-based product was appropriate for the particular paint stripping task. They provided a comment that quotes from the preamble to the proposed rule that the evaluation criteria in the management plan would involve “only using MeCl-containing paint stripper when an alternative on site stripper method or material is incapable of accomplishing the work as determined by the operator.” *Response:* The rule does not limit or ban the use of MeCl-based paint strippers. The rule also does not say when a facility can use or cannot use MeCl-based paint strippers. Instead, the rule encourages operations to think of ideas specific to their operation where alternative stripping technologies can be employed. The facility has the obligation to determine whether and when it can most effectively substitute alternative technologies for MeCl-containing stripper. In some cases a facility may find that MeCl strippers may currently be the only feasible choice; however, in other cases these strippers may currently be used as a matter of routine and suitable alternatives can be used instead. The basis of the rule is to consider, and when possible, to use alternative stripping techniques. There are situations where alternative stripping methods can be employed successfully. Examples of alternative techniques for wood include sanding off the top layers of paint and using a smaller amount of MeCl-containing stripper to remove the remaining paint. Another would be to sand the flat surfaces and use the MeCl-containing stripper to remove the paint from only certain areas such as carvings or joinings. D. Authority To Regulate Miscellaneous Surface Coating Operations *Comment:* A commenter argued that plastic parts and product surface coating should not be listed as an area source of the specific heavy metals in urban areas. The commenter stated that the major source rule for plastic parts surface coating (40 CFR Part 63 subpart PPPP) did not regulate heavy metal emissions and did not require the use of spray booths. The commenter also stated that heavy metals were not mentioned in the proposed or final major source rule. The commenter also contended that the listing of plastic parts and products was not consistent with EPA's stated policy for listing sources of HAP (64 FR 38720, July 19, 1999) and heavy metal HAP (64 FR 38722). The commenter further stated that the analysis in the preamble to the proposed area source rule indicates that plastic part surface coating sources account for only about 700 pounds a year, or between 0.15 percent and 0.33 percent of total area source heavy metal emissions. The commenter requested EPA to change the listing decision and remove plastic parts coating operations from the rule. *Response:* The listing and regulation of plastic parts and products (surface coating) for the targeted metal HAP is consistent with CAA requirements. Sections 112(c) and 112(k) of the CAA instruct EPA to identify and list area source categories accounting for at least 90 percent of the emissions of the 30 listed HAP (referred to as “urban HAP”) (64 FR 38706, July 19, 1999). One of the listed area source categories is plastic parts and products (surface coatings). The commenter provides no information indicating that this listing was inappropriate. In the 1999 final urban air toxics strategy notice, we listed 16 area source categories including paint stripping. Each of these categories accounted for at least 15 percent of at least one of the 30 urban HAP. See 64 FR at 38720. But, as indicated in that notice, the initial list of area source categories did not account for 90 percent of several of the HAP, including six metal HAP (64 FR 38722, July 19, 1999). That notice announced EPA's intent to study additional area source categories and complete the list of area source categories by 2003. In June 2002, we listed several additional area source categories including autobody refinishing (67 FR 43122, June 26, 2002). That listing, however, still did not meet the requirement to list area sources representing 90 percent of the area source emissions of each of the 30 HAP. In the urban air toxics strategy, EPA indicated we would be adding additional area source categories as necessary to meet the 90 percent requirement. Consequently, in November 2002, we listed 23 additional area source categories including plastic parts and products (surface coating) (67 FR 70428, November 22, 2002). Each of these listed categories contributes some percentage of emissions of one or more of the 30 urban HAP. The plastic parts and products (surface coating) area source category was listed for cadmium, chromium, lead compounds, manganese, and nickel compounds. In order to meet the 90 percent requirement for each of the 30 urban HAP, we had to list many categories that individually contributed only a small percent of the target HAP. This history and the CAA requirements for area sources explain why the metal urban HAP are the target of the surface coating portion of this area source rule. We are required during rule development to regulate emissions of the target urban HAP from surface coating area sources. Under section 112(d) area source regulations may be based on GACT rather than MACT, which is required for major sources. In this rule we have established emissions standards that represent GACT for the source categories. The commenter has provided no information questioning the GACT determination in the proposed rule. *Comment:* One commenter stated that the rule should not regulate surface coating on metal parts and products as part of the miscellaneous surface coating source category because it was not listed as an area source category. The commenter noted that the category included in the final notice for the list of source categories in November 2002 2 was “plastic parts and products (surface coating).” The commenter also noted that the description of this source category in supporting documents for that listing includes industrial classification codes only for plastic parts and products. However, the commenter notes that the standard industrial classification code for miscellaneous metal surface coating (SIC 3479) was included in the source category description for “autobody refinishing paint shops.” 2 67 FR 70427 (November 22, 2002). *Response:* The EPA's decision to list plastic parts and product (surface coating) as an area source category was based on analysis of emissions data from over 20 different SIC codes that represent manufacturers of parts and products that contain both metal and plastic substrates. These included, for example, architectural metal work; games, toys, and childrens' vehicles; motor homes; motor vehicle parts and accessories; motor cycles, bicycles, and parts; musical instruments; transportation equipment not elsewhere classified; and truck and bus bodies. These analyses were documented in “1990 EMISSIONS INVENTORY OF FORTY POTENTIAL § 112(k) POLLUTANTS, SUPPORTING DATA FOR EPA'S § 112(k) REGULATORY STRATEGY, Final Report” (May 21, 1999). A copy of the relevant portions of this document has been included in the docket for this final rulemaking. Since the analysis of the inventory included a broad sampling of both metal and plastic surface coating that were identified as sources of the target HAP, the EPA is regulating both metal and plastic surface coating operations in the final rule. To more accurately reflect the scope of the regulated operation, we refer to them in the final rule as “miscellaneous surface coating operations” and describe them more completely in the applicability section of the final rule. E. Basis of Surface Coating Standards *Comment:* Some commenters believed that the requirements for spray booths and painter training, particularly applied to very small miscellaneous surface coating operations and those that apply coatings to large parts or subassemblies, are beyond GACT. Some commenters suggested that EPA should collect additional information on the types of spray equipment and practices being used, coatings being employed, and product rates at small sources. They claim that the requirements for spraying automotive coatings do not necessarily carry over well to the miscellaneous surface coating operations. Other commenters supported the proposed standards as GACT. *Response:* The EPA disagrees that spray booths and painter training are beyond GACT for sources using coatings containing the target HAP. The analyses performed in support of the proposed rule demonstrate that painter training and filtered spray booths are both commonly employed by miscellaneous surface coating sources of all sizes. However, the EPA has revised the proposed rule such that painter training and spray booths are only required for miscellaneous surface coating operations that spray apply coatings that contain the target HAP. Miscellaneous surface coating operations that do not use coatings that contain the target HAP will not be subject to these requirements. However, all motor vehicle and mobile equipment surface coating operations would still be subject to the requirements of the final rule. F. Training Requirements *Comment:* Several commenters felt that the training standards could be interpreted to apply to all painters, and those standards should only apply to spray coating operations. Painters in non-spray coating operations should not be required to complete training. Other commenters noted that training would not benefit the operators of automated or robotic surface coating operations, and these operations should be exempt from the training requirements. *Response:* The rule has been clarified, as suggested by several commenters, to clearly apply only to painters that spray apply coatings using hand-held devices. Painters using brushes and rollers, and other non-spray application methods, are not subject to the training requirements. In addition, all automated and robotic surface coating operations are not required to meet these requirements since these operations are not considered part of the intended source category. Automated operations are typically performed in a booth, are part of a production line operation with similar, if not identical, parts, and often result in high transfer efficiency. *Comment:* One commenter suggested that painting is an art form not possessed by everyone and a test and certification should not be used to dictate who works as a painter. Another painter asked whether the rule would include a grandfather clause that would exempt experienced painters based on their length of time in the business or years experience painting. One commenter suggested that retraining every five years is not needed because of the daily experience of painting. *Response:* The EPA agrees that spray painting is a skill that is not easily mastered, and that shop owners will avoid hiring and keeping poorly performing spray painters. However, information collected by EPA in development of the proposed rule has shown that even experienced spray painters can improve their transfer efficiency and reduce emissions and paint consumption through appropriate training. Therefore, the final rule retains the training requirement for all spray painters at motor vehicle and mobile equipment surface coating operations, and for all spray painters that use coatings containing the target HAP at miscellaneous surface coating facilities. The final rule will allow painters who have completed formal training in the past five years to use that training to demonstrate compliance. Refresher training is retained in the final rule since it is important to ensure that painter techniques do not revert back to those that were used before training, and also so painters can be brought up to date on current technologies. *Comment:* One commenter suggested that the rule should allow 180 days after hiring for new painters to be trained, instead of 60 days, as well as for new painters at existing facilities. *Response:* The EPA agrees and the rule has been revised to allow 180 days after hiring, or after completing a transfer within a facility to a painting job, for new painters to complete the prescribed training. *Comment:* Several commenters were concerned about the availability of training and the suitability of training for the particular type of surface coating that they perform, or the type of workforce they have. Some commenters noted that their painters may not speak English, or be able to perform well in a typical classroom setting or in a testing environment. In these cases, a formal certification may be difficult for their painters to achieve. One commenter noted that inmates participating in prison industries could not be sent to outside training. Other commenters were concerned that training should not be limited to any one type of program or it could create a limited market of providers and costs may not be affordable for small shops. They suggested that the rule language should be more specific about the criteria that would indicate a training program meets the minimum requirements. *Response:* The EPA agrees that training should not be limited to any one provider or a small number of providers, and should be available and affordable for all sizes and types of shops. The final rule includes additional detail on the training requirements so that alternative training programs can be developed that meet the minimum requirements and meet the particular needs of different types of shops. For example, the EPA recognizes that some larger employers may wish to develop in-house training programs that are focused on the materials, products, and procedures used at a particular facility. The final rule does not specify that any one training provider or program must be used. The final rule allows flexibility for the best training environment and certification process that an owner or operator can identify for their particular work site that meets the requirements in the final rule. The training requirements have been revised to allow for in-house training programs and for successful completion of a training program to be certified by the owner of the facility. *Comment:* Several commenters suggested that if the EPA is expecting industry to provide certification or training programs, the rule should make provisions for a certifying agency or program certification procedures. One commenter asked whether training programs would need to meet a set of standards, and whether a manufacturer, trade school, or consultant would be required to submit curriculum to EPA for prior approval. Another commenter recommended that training programs used to meet this regulation should be validated or certified by an independent clearinghouse. The commenter suggested that EPA should delegate this responsibility to a proven program that has a history of developing and providing paint technician training, since the EPA does not have the necessary painting experience to do this. *Response:* The EPA does not believe that it is necessary to establish or designate a body to certify or approve training programs to comply with the requirements in the final rule. The final rule includes sufficient detail on the training requirements so that training programs can be developed that meet the minimum requirements. The EPA feels that painters and the shops that employ them are the most appropriate judge of different training programs, due primarily to the economic benefit they can realize through good training. Since the shop owner or the painter will need to absorb the initial cost of training (even though it should represent a coating cost savings in the long run), it will be up to painters and shops to identify and evaluate training programs that best meet the requirements of the final rule and which seem to be the best investment of their time and resources. To the extent that additional guidance on the training requirements in the final rule is needed, the EPA will work with all affected parties to develop that guidance. G. Spray Gun Requirements *Comment:* Several commenters state that a number of spray coating applications cannot be accomplished using HVLP, electrostatic guns, or equivalent techniques. Two commenters stated that EPA determined during the development of the NESHAP for Aerospace Manufacturing and Rework Facilities (40 CFR 63, subpart GG) and other major NESHAP rules that high solids coatings cannot be applied using HVLP, or equivalent methods. *Response:* The final rule includes the same exemptions from the HVLP requirements for aerospace manufacturing and rework facilities as subpart GG. The rule was revised to exempt any situation that normally requires the use of an airbrush or an extension on the spray gun to properly reach limited access spaces; the application of coatings that contain fillers that adversely affect atomization with HVLP spray guns, and the application of coatings that normally have a dried film thickness of less than 0.0013 centimeter (0.0005 in.). The technical basis for these allowances for aerospace surface coating operations was established in the development of subpart GG. Since there is no technical difference between these aerospace surface coating operations at area and major sources (aside from the relative size of these operations), the EPA is including the same allowance in the final rule as found in subpart GG. *Comment:* Several commenters requested that airless and air-assisted airless spray guns should be considered equally efficient and equivalent to HVLP, and requested that EPA treat airless spray equivalent to HVLP for the purpose of this rule. One commenter stated that airless spray operations are very common for most miscellaneous parts surface coating operations and should be considered as a viable and authorized option. Another commenter provided an example of a structural steel facility that uses a high viscosity, high solids coating as being an operation that could not employ HVLP spray guns. The commenter stated that such operations generally use airless spray guns to apply high-viscosity, high solids primers. Another commenter stated that while HVLP spray guns and gravity fed supply lines are well suited for the automotive refinishing industry, pressure fed application equipment is best suited and typically used in other miscellaneous sectors. Other sectors use coatings that have characteristics much different from automotive coatings. Quite often, these coatings are higher in viscosity because of higher solids content, compared to automotive coatings. *Response:* The final rule requires that miscellaneous surface coating operations are only required to employ HVLP, or equivalent, spray guns if they are spraying coatings that contain the target HAP. Motor vehicle and mobile equipment surface coating operations must use HVLP or equivalent spray guns for all surface coating. The rule was also revised to allow airless and air-assisted airless spray guns as alternatives to HVLP. Airless and air-assisted airless spray guns are used in some applications instead of HVLP spray guns because they are more suited to spraying higher solids coating, such as in the fabrication of large structural steel components, and in applying coatings to ships and other marine items. In these cases, HVLP spray guns are not feasible because of the viscosity of the coating, and airless and air assisted airless spray guns are the most efficient means to spray apply these coatings. H. Spray Booths *Comment:* Several commenters stated that requiring spray booths is not practical, realistic, or economically feasible for some facilities performing coating on work pieces that are too large to fit in a booth such as large structural metal work pieces, fixed equipment, structural steel, and large mobile equipment. Several commenters also stated that requiring spray booths for these types of operations would make the rule more stringent than the MACT rules for the corresponding industries. One commenter provides an offshore drilling rig as an example of mobile equipment that is too large for a spray booth. Two commenters requested that the rule include an exemption for the surface coating of oversized parts. *Response:* The proposed rule was revised so that it does not apply to miscellaneous surface coating operations that do not spray apply coatings that contain the target HAP. The proposed rule was also revised to clarify that it does not apply to facility maintenance of fixed equipment and architectural surface coating of stationary structures. The final rule has not been revised to specifically exempt the surface coating of large objects from the spray booth requirement. However, the surface coating of large objects would not be subject to the requirements of the final rule if the coatings that are spray applied do not contain the target HAP, the surface coating operation of the object met the definition of facility maintenance, or the surface coating was done using non-spray application methods. The EPA believes that the surface coating situations described by the commenters involving large objects all fall into at least one of these categories. Therefore, they would not be subject to the requirement to use a spray booth and an exemption for large objects is not specifically required by the information provided by the commenters. *Comment:* Three commenters expressed concern regarding the language requiring negative pressure paint booths. The reason for this concern is that for critical finishes, such as automotive surface coating, negative pressure may cause airborne dust and dirt to be drawn into the booth and mar the finish. As a result, downdraft paint booths used for automotive surface coating are usually ventilated at slight positive pressure so that contaminants are kept out of the booth, although door seals and filtration systems are still used to protect air quality. One commenter suggested that in applications that require a dust/dirt free finish, and where the spray booth is totally sealed and the booth control system utilizes an automatic pressure balance system, spray booths should be allowed to operate at up to, but not more than, 0.05 inches water gauge positive pressure. *Response:* The final rule was revised to allow for downdraft spray booths that are balanced at slight positive air pressure and incorporates the recommended language. The EPA observed several spray booths of this configuration during site visits in the development of this rule and agrees that with appropriate door seals and filtration systems these booths are as protective of the environment as booths operated at negative pressure. *Comment:* Several commenters stated that the EPA has understated the impacts of the proposed requirement to use a spray booth for all spray finishing operations. The commenters noted that EPA did not assign any costs to the requirement to use a spray booth because the EPA had assumed that spray booths would already be required in order to comply with OSHA standards for spray finishing operations under 29 CFR 1910.94(c). The commenters argued that OSHA standards require a spray booth only if certain exposure conditions are met, and these exposure conditions can be avoided with, for example, the use of waterborne coatings or outdoor spraying operations. Other examples of spray coating operations that can be conducted outside of a filtered spray booth in compliance with OSHA include automotive undercoating, areas of low coating use with adequate ventilation, powder coating, waterborne products, and touch-up and repair coating. *Response:* The EPA acknowledges that there are situations in which OSHA does not require surface coating to be performed in a filtered spray booth. That being noted, the rule was revised to clarify that the scope of the source category does not include miscellaneous surface coating operations if the coating being used does not contain the target HAP, facility maintenance surface coating and other architectural surface coating of stationary structures, powder coating and the spray application of coatings from a spray gun with a cup size equal to or less than 3.0 fluid ounces (89 cc). Given the clarified scope of the surface coating operations that are subject to the spray booth requirements in the final rule, the EPA believes that there is a substantial overlap between the operations that would be performed in a spray booth to comply with OSHA standards for spray finishing operations and those that would be required to do so by this rule. Therefore, the EPA does not believe that we have substantially underestimated the cost of the final rule. *Comment:* Two commenters pointed out that EPA did not address enclosing automated or robotic spray systems in a spray booth. One commenter stated that the costs for doing so could be very high and requested that EPA exempt all fixed point automatic spray installations from this rule. Another commenter stated that the proposed rule did not include language that addressed spray booth configurations with openings for conveyor lines that carry parts through a booth. The commenter suggested that the openings for conveyors would be equal to no more than the area of the open face of a three-sided spray booth. *Response:* The rule was revised to clarify that automated or robotic spray operations were not considered within the scope of the source category, as the source categories for surface coating were intended to cover coating that is spray applied using hand-held devices. The EPA acknowledges that miscellaneous surface coating operations may be spray applying coatings that contain the target HAP using conveyor line configurations, and the rule was revised to account for openings needed on side walls and roofs of spray booths to accommodate the conveyor lines. *Comment:* One commenter noted that spot repairs on automobiles can be performed using commercially available portable extraction systems. One such system consists of a ring that is placed around the area to be repaired. The ring is hollow and is attached to a ventilation system so that air and overspray are drawn into the ring placed around the area being repaired. The commenter asked whether this would be an acceptable alternative to a spray booth for small spot repairs. *Response:* The EPA reviewed the product information cited by the commenter and agrees that portable or mobile enclosures and extraction systems such as the one cited by the commenter are reasonable alternatives to a full size paint booth for small repairs. The paint booth requirements in the final rule have been revised to allow for the use of portable enclosures and extraction systems that can be used to enclose only the area being refinished in a spot repair. The enclosure would still need to be ventilated so that air is drawn into and paint overspray is captured by the enclosure, and it would also need to meet the same requirements for spray booth filters as full size spray booths. I. Spray Booth Filters *Comment:* Several commenters stated that requiring facilities to demonstrate compliance by testing for filter efficiency places an undue burden on any facility attempting to use a more efficient filter. Vendor guarantees or specifications should be sufficient for compliance. *Response:* It was the intent of EPA that filter specifications or filter performance data provided by the filter manufacturer would suffice for the purpose of compliance in the proposed rule. The final rule clarifies that records of manufacturer specifications or vendor supplied or published data are sufficient for demonstrating compliance with the filter efficiency requirement. Operators are not expected to have to perform the test since it is usually done by the filter vendors. *Comment:* One commenter stated that waterwash filters were not discussed in the proposed rule. The commenter requested that EPA assess the acceptability of water wash booths as a control technology for overspray. *Response:* The final rule was revised to state that waterwash spray booths will be acceptable for the purposes of complying with the rule as long as they are used and maintained according to manufacturer specifications and consistent with good air pollution control practices. Although many waterwash spray booths have been replaced or retrofitted with dry filters, there are some applications where waterwash spray booths are still the most practical technology to control paint overspray. Since EPA believes that properly operated and maintained waterwash spray booths are nearly as efficient as required by this rule for dry filters and it would not be cost-effective to require retrofitting with dry filters, considering the potential limited increase in capture efficiency, the final rule provides for the use of waterwash spray booths, but requires that they be operated and maintained according to the manufacturer's specifications. *Comment:* One commenter stated that the paint overspray filter criteria are inconsistent. The commenter requests that if 98 percent overspray filter efficiency is the criteria, then it should be required for all paint overspray filters. The commenter speculated that by stating in the regulation that any fiberglass or polyester filter is acceptable, the practice of using cheap, low efficiency furnace filters could grow. The commenter suggested that specifying a minimum filter efficiency of any medium would be more effective at reducing particulate emissions. *Response:* The final rule was revised so all spray booth dry filters, regardless of media, are required to meet the 98 percent efficiency standard. The rule was also revised to clarify that records of manufacturer's specifications or filter performance data are sufficient for demonstrating compliance with this performance level. J. Spray Gun Washers *Comment:* One commenter stated that the need for enclosed spray gun washers may be over emphasized since the intent of the rule is to prohibit the atomization of solvent through the gun into the air. Although the proposed rule indicates that spray equipment may be dismantled and cleaned in lieu of a gun washer system, this alternative seems overshadowed by the gun wash option and may be lost in the rule interpretation. Other commenters reported that some commercially available enclosed gun washers were less efficient and more difficult to use and maintain than simply disassembling a spray gun and cleaning it by hand in a container of solvent. Two commenters stated that the rule should allow for equipment to be cleaned by spraying a non-HAP containing solvent through the applicator outside of an enclosed gun washer. *Response:* The final rule was revised to clarify that if washing a gun, an affected facility is prohibited from spraying cleaning solvent through the gun in a way that creates an atomized mist that is not captured. The intent of this requirement is to prevent the emission of the target HAP that is in the paint residue that remains in the spray gun. The EPA agrees that an enclosed gun washer is not needed to meet this objective. To comply, you may, for example, clean a disassembled gun by hand in a bucket or vat, flush solvent through the gun without atomizing it and capturing the solvent in an enclosed container, or use an enclosed manual or automatic gun washer. The final rule does not require the use of an enclosed gun washer, but identifies an enclosed gun washer as one compliance option in addition to the other options suggested by the commenters. K. Reporting, Recordkeeping, and Compliance *Comment:* A commenter felt that it would be more suitable for sources to keep the MeCl minimization plan for paint stripping operations on site rather than submitting it to the State and EPA. They stated that States and EPA would not have the time or resources necessary to review the plans, and that they were unsure what kind of review/approval process should be used. Another commenter stated that since the proposed standard imposes management practices rather than emissions limits, it is not clear what aspect of their compliance activity sources would need to report. They suggest that beyond the initial report, the only reporting that should be necessary would be a change in status relative to the threshold level for developing a MeCl minimization plan. *Response:* The development and implementation of the MeCl minimization plan is designed to reduce MeCl usage and emissions at the facility level. In the proposed rule, the requirement to submit the MeCl minimization plan was included to ensure that there would be oversight of facilities' plans. However, EPA understands the commenter's point that the value of submitting them to the State or EPA would likely not offset the burden of time and resources for submittal and review. As a result, the final rule was revised so that it does not require facilities to submit their plans to State or local agencies, or the EPA. The final rule requires them to keep their plans on site and to include a statement in their initial notification or notification of compliance that they have developed their plans and met the requirements associated with the MeCl minimization plan. The final rule also includes a requirement for facilities to review their plans annually and to make changes as appropriate based on their experiences in the previous year. Documentation of this review will also replace the proposed rule requirement to submit annual compliance reports to the permitting authority. While the final rule does not require submission of the MeCl minimization plan, facilities that are required to develop plans must still submit an initial notification and a notification of compliance, and meet annual MeCl minimization plan review, revision, and recordkeeping requirements. *Comment:* One commenter indicated the annual reporting time and costs appeared to be underestimated unless simple materials are developed to help streamline the efforts of small businesses to complete this reporting. The commenter predicted that small businesses would spend closer to 15 hours or more to develop something on their own and to compile all the information alone would probably take six to eight hours. If a small business owner tries to minimize his or her time spent on the report, they would have to hire a consultant at $100 per hour or more. The consultant may take just six hours to complete the work, but that total cost would be $600 instead of $219, according to the commenter. Other commenters also indicated that the reporting burden had been underestimated. Some commenters questioned whether EPA had considered the cost to EPA, State, and local implementing agencies to perform outreach and assist sources to comply, receive initial notifications, conduct field inspections, and process annual certifications. Some commenters also said that initial notifications, compliance status notifications, and annual compliance reports would place an undue burden on facilities and State agencies. One commenter suggested allowing sources to maintain records of compliance on site and make them available upon request for local, State, or Federal inspection without submission of annual reports. Another suggested the following for autobody refinishing shops: Combine the initial notification with the notification of compliance status, eliminate the annual reports, keep file copies of training certifications for currently employed painters, eliminate some other records including records of deviations, and possibly the requirement to keep records for five years. *Response:* The EPA has revised the rule to reduce the notification and reporting burden to sources and the burden to State and local agencies receiving the notifications and reports, while still retaining information needed to implement and enforce the rule. In particular, the final rule does not require facilities to submit annual compliance reports. Therefore, after the one-time initial notification and notification of compliance status (if needed), there will be no regular annual reporting burden to sources, and the implementing agencies will not need to review and track thousands of annual compliance reports. Sources will only need to submit a report if there is a change in the information contained in the initial notification, notification of compliance status, or a previous annual notification of changes report. This is a reasonable approach that reduces the burden on regulated sources, but provides EPA and delegated States with necessary compliance information. If there are no changes in a given year, the report would be identical to what was previously submitted, either in an earlier annual report, in the initial notification, or in the notification of compliance status. Therefore, EPA believes it is appropriate to require a report only if the relevant information has changed. Sources will still be required to submit an initial notification that they are subject to the rule. The notification contains a very brief description of the operation that is subject to the rule; however, the type of information that should be included is minimal, clearly explained in the rule, and should be readily available to the owners and operators of motor vehicle and mobile equipment surface coating shops, or miscellaneous surface coating operations. The initial notification is needed so that implementing agencies will have a list of sources that are subject to the rule and will know with which part of the rules each source must comply (e.g., surface coating or paint stripping). This is necessary so that implementing agencies can target outreach, inspection, and enforcement efforts. In addition, sources will continue to be required to keep the proposed records to demonstrate compliance. These records are limited to painter certification records, documentation of spray booth filter efficiencies (which are expected to be supplied by the manufacturer), documentation from spray gun manufacturers (only if the source is using a spray gun other than the types listed in the rule), records of usage of paint strippers containing MeCl, and records of deviations from the rule requirements. The content of the required records is clearly explained in the rule, and the records can be kept in whatever format is easiest for the shop (hard copies or electronic). These records are the minimum level of information needed for an inspector to determine if a source is complying with the rules. The EPA has not reduced the amount of time that records must be retained. The records that must be retained are minimal and reducing the time they are kept from five years to two years would not affect the burden of storing these minimal records. In addition, the longer record period is the minimum needed to verify compliance with the training requirements since refresher training is needed every five years. The longer record period is also needed to ensure that paint stripping sources that have to complete a MeCl minimization plan are consistently reviewing and updating the plan on an annual basis. L. Cost and Economic Impacts *Comment:* Several commenters said that the number of area sources that perform miscellaneous surface coating is much larger than EPA estimated. These estimates were based on the number of miscellaneous surface coating sources known to regulatory agencies in different States. The commenters estimated that the total number of sources subject to the rule could be about 200,000 nationwide, and many of these could be small businesses. Another commenter believed that EPA has not met the criteria needed to certify that there will not be a “significant impact on a substantial number of small entities” (SISNOSE) as needed under the Regulatory Flexibility Act
(RFA)and has underestimated the cost and economic impacts because the rule would require many sources to install spray booths and obtain operator training. *Response:* The EPA agrees that the number of sources that could have been affected by the proposed rule, if interpreted to apply to all miscellaneous surface coating operations, was higher than estimated at proposal. However, the EPA has revised the final rule to clarify the intended sources to which it would apply, and to reduce the actual number of affected sources subject to the rule. Miscellaneous surface coating facilities that do not spray apply coatings that contain the target HAP will not be subject to the final rule. The EPA believes that these changes in the final rule will more accurately reflect the number of sources that are potentially subject to the rule, and for which the proposed economic impacts were based, since only a fraction of miscellaneous surface coating sources use coatings that contain the target HAP. Based on the datasets available to EPA for the miscellaneous surface coating source category and additional information submitted by several commenters, EPA estimates that less than 10 percent of the total population of sources are spray applying coatings that contain the target HAP. In addition, many miscellaneous surface coating sources that are currently using coatings that contain the target HAP may be able to avoid being subject to the rule by either switching to coatings that do not contain the target HAP, or switching to non-spray application technology. Based on these changes, the EPA believes that the rule will not have an adverse impact on those facilities. VI. Summary of Environmental, Energy, and Economic Impacts The EPA estimates that about 39,000 establishments performing paint stripping, motor vehicle and mobile equipment, or miscellaneous surface coating operations would be subject to the final rule. We estimate that about 3,000 of these establishments are paint stripping facilities and 36,000 establishments are surface coating operations. The majority of these surface coating establishments (about 35,000) are involved in motor vehicle and mobile equipment refinishing, and employ about 263,000 people, of which about one-third are painters. A. What are the air impacts? Paint Stripping Operations The baseline MeCl emissions from paint stripping operations are estimated to be 3,800 tpy. Around 500 tpy is estimated to be emitted from the approximately 2,000 facilities that annually use paint stripper containing one ton of MeCl or less. The remaining 3,300 tpy is estimated to be emitted by the approximately 1,000 paint strippers that annually use paint strippers containing more than one ton of MeCl and who would be required to develop a MeCl minimization plan. Miscellaneous Coating Operations The baseline emissions from the surface coating operations are estimated to be about 38,000 tpy of HAP, including 12.4 tpy of inorganic HAP (e.g. Pb and Cr-VI compounds). In addition to the HAP, baseline emissions of criteria pollutants are estimated to be 3,100 tpy of particulate matter
(PM)from paint overspray and 120,400 tpy of volatile organic compounds
(VOC)from coating and solvent evaporation. Implementation of the final standards would achieve a reduction of 6,900 tpy of HAP from surface coating operations, including about 11.4 tpy of inorganic HAP. In addition to the HAP, we estimate PM reductions of about 2,900 tpy and VOC reductions of about 20,900 tpy. These reductions would occur as a result of reduced use of HAP-containing solvents and coatings, increased use of filtered spray booths to capture overspray, increased spray painter training, and use of HVLP or equivalent guns to improve transfer efficiency and to reduce coating overspray and paint consumption. Additional detail on these calculations are included in the public docket for this rulemaking. B. What are the cost impacts? Paint Stripping Operations We estimate that the final standards for paint stripping operations will result in an initial cost of around $1,500,000 and a net savings in annual costs. This includes an estimated initial cost of $490,000 and annual costs of $80,000 for the nearly 2,000 paint strippers who annually use paint stripper containing one ton of MeCl or less. Initial costs for the approximately 1,000 paint strippers who annually use paint strippers containing more than one ton of MeCl, who would be required to develop MeCl minimization plans, are estimated to be just over $1 million. The annual costs for those plants are estimated to be a net savings of $910,000. For the nearly 2,000 paint strippers who annually use paint strippers containing one ton of MeCl or less, switching to alternative non-MeCl paint stripping methods comprise most of the costs. The costs for the approximately 1,000 paint strippers who are required to develop MeCl minimization plans are attributable to the development and implementation of the MeCl minimization plan. Annual costs will include an estimated $400,000 for the development and implementation of the MeCl minimization plan and an estimated $450,000 associated with switching paint stripping technologies. Annual savings resulting from the implementation of the MeCl minimization plan include an estimated $420,000 from the elimination of unnecessary stripping operations and $1,320,000 in management practice savings from the reduced use of MeCl-containing strippers. Additional detail on these calculations are included in the public docket for this rulemaking. Miscellaneous Coating Operations We estimate that the final standards for surface coating operations will have no net annual cost to surface coating operations. The initial cost of complying with the final standards would be off-set and recovered over time by cost savings as a result of more efficient use of labor and materials by surface coating operations. The initial costs for surface coating operations are for purchasing improved spray booth filters, HVLP or equivalent spray guns, and painter training, if needed to comply with the final standards. Spray finishing operations are already required by OSHA standards to perform spray painting in a spray booth or similar enclosure. However, the final standards specify that certain types of filters have to be used on the spray booth exhaust to minimize HAP emissions, and these filters are not addressed by OSHA standards. Some surface coating sources may need to replace their current filters for ones with higher paint overspray capture efficiency, but the higher efficiency filters are readily available and will not result in an additional cost. The estimated cost for training is $1,000 per painter, which covers tuition cost and labor cost for 16 hours of training time. Based on the United States census data collected to estimate new sources for this source category the number of refinishing shops in the United States remain constant (i.e., for every new shop, a shop closes) and it is expected that this trend will continue in the future. This reflects on the number of new painters that would need training. We assumed that training certification would be valid for five years, so about one-fifth of painters (20 percent) would receive training every year. We estimate that about 18,000 painters would be trained per year at an annual cost of $18 million per year. However, EPA believes that these training costs could be over-stated for at least two reasons. First, many facilities already send their painters to training sponsored by paint companies and trade organizations. Paint companies sponsor painter training so that the paint company can reduce warranty claims on their paint products. These training courses already cover much of the same material required by the final rule. Therefore, the rule would not impose new training costs on these facilities that already participate in training. Second, the estimated training cost could be offset by reduced coating costs if the training results in reduced coating consumption. Data from the STAR® training programs indicate that painters who complete this training can decrease the amount of coating sprayed by about 20 percent per job. We estimate that if a typical facility reduced their coating consumption and costs by about four percent per year, the cost savings would equalize the increased cost of training after one year, and there would be no net cost in training. To recover the cost of training over five years, a typical facility would need to reduce their coating consumption by slightly less than one percent. In summary, EPA estimates that the final requirements for surface coating operations would not result in any net increase in annual costs from the control requirements for surface coating operations. We estimated that the annual cost for recordkeeping and reporting for surface coating operations would be $7.8 million for about 36,000 surface coating operations, or an average of about $220 per facility. Cost estimates are based on the information available to the Administrator and presented in the economic analysis of this rule. Additional detail is included in the public docket for this rulemaking. C. What are the economic impacts? The economic impact analysis focuses on changes in market prices and output levels. A more detailed discussion of the economic impacts is presented in the economic impact analysis memorandum that is included in the docket. Both the magnitude of control costs needed to comply with the rule and the distribution of these costs among affected facilities can have a role in determining how the market prices and quantities will change in response to the rule. In this case, we have so many facilities that model facilities must be used in the cost analysis. The cost analysis estimates that there will be no net increase in annual costs from the control requirements from the final regulation for surface coating operations. The record keeping and reporting costs are estimated to range from $76 to $95 per facility per year. These costs are too small to have any significant market impact. Whether the costs are absorbed by the affected facilities or passed on to the purchaser in the form of higher prices, the impacts would be quite small. The cost analysis estimates that there will be a net cost savings from the control requirements, recordkeeping, and reporting from the final regulation for paint stripping for all but the smallest model plant. The cost for the smallest model plant is estimated to be $11 a year. Again, these costs are too small to have any significant market impact. Whether the costs are absorbed by the affected facilities or passed on to the purchaser in the form of higher prices, the impacts would be quite small. While most of these facilities are small, the very small costs are not expected to be even a tenth of a percent of revenues. Thus a significant impact is not expected for a substantial number of small entities. D. What are the non-air health, environmental, and energy impacts? Paint Stripping Operations We estimate that there will be a reduction in non-air health and environmental impacts resulting from the paint stripping area source NESHAP. Reduced usage of MeCl-containing chemical strippers will result in reduction in waste water generated from rinsing chemically stripped pieces. Additionally, reduced chemical stripping activity will result in a reduction in the generation of hazardous wastes composed of rags and other chemical stripper applicators and removal equipment. EPA expects some increase in the need for energy resulting from switching away from MeCl-containing chemical strippers to other paint stripping methods. There would be a slight increase in energy usage associated with switching to other chemical strippers that do not contain MeCl because they often need to be heated above room temperature to be most effective. There is also some increase in energy usage associated with non-manual mechanical stripping and blasting with both dry and wet media. The energy usage increase would be somewhat more for thermal decomposition or cryogenic paint stripping technologies. Thermal decomposition basically uses natural gas heated ovens to bake the paint off the substrate. Cryogenic paint stripping methods have increased electricity demands associated with the production of liquid nitrogen or liquid carbon dioxide. Surface Coating Operations We estimated that about 5,000 surface coating operations, primarily motor vehicle refinishing operations, would need to install spray booths to comply with the final standards. Spray booths would need electricity to run fans and natural gas to heat make-up air to maintain facility temperatures in colder weather. We estimate that this would lead to an increased electricity consumption of 9.8 million kilowatt hours per year and increased natural gas consumption of 724 million cubic feet per year. However, spray booths are already required for spray finishing operations to comply with OSHA standards, so these impacts would not be assigned to these final standards. Facilities that install spray booths would also need to dispose of used spray booth filters. These are often placed in a sealed drum to prevent spontaneous combustion and disposed of as hazardous waste. We estimate that 5,000 new spray booths could generate used filters equal to about 8,000 drums per year. We expect no increase in generation of wastewater or other water quality impacts. None of the control measures considered for this rule generates a wastewater stream. The installation of spray booths and increased worker training in the proper use and handling of coating materials should reduce worker exposure to harmful chemicals in the workplace. This should have a positive benefit on worker health, but this benefit cannot be quantified in the scope of this rulemaking. VII. Statutory and Executive Order Reviews A. Executive Order 12866: Regulatory Planning and Review Under Executive Order
(EO)12866 (58 FR 51735, October 4, 1993), this action is a “significant regulatory action.” Accordingly, EPA submitted this action to the Office of Management and Budget
(OMB)for review under EO 12866 and any changes made in response to OMB recommendations have been documented in the docket for this action. B. Paperwork Reduction Act The information collection requirements in this rule have been submitted for approval to the OMB under the Paperwork Reduction Act, 44 U.S.C. 3501 et seq. The information collection requirements are not enforceable until OMB approves them. The information collection requirements are based on notification, recordkeeping, and reporting requirements in the NESHAP General Provisions (40 CFR part 63, subpart A), which are mandatory for all operators subject to national emission standards. These recordkeeping and reporting requirements are specifically authorized by CAA section 114 (42 U.S.C. 7414). All information submitted to EPA pursuant to the recordkeeping and reporting requirements for which a claim of confidentiality is made is safeguarded according to Agency policies set forth in 40 CFR part 2, subpart B. The standards would require sources to submit an initial notification that they are subject to the standards, submit a notification of whether or not the source is in compliance (the notification of compliance status) and keep records needed to demonstrate compliance. These requirements would be the minimum needed to ensure that sources were complying with the requirements of the rule. EPA estimates that about 40,000 existing area sources would be subject to the standards. EPA also estimates that about 1,600 new facilities would open per year in the three years following promulgation of the standards, but that the total number of facilities would remain constant as new facilities replace facilities that have closed. New and existing sources would have no capital costs associated with the information collection requirements in the standards. The estimated recordkeeping and reporting burden in the third year after the effective date of the promulgated rule is estimated to be 62,877 labor hours at a cost of $2.2 million. This estimate includes, depending on the type of source, the cost of keeping records of paint stripping solvent consumption, painter training, spray booth filter efficiency, and spray gun transfer efficiency. The average hours and cost per facility would be 6.4 hours and $219. Burden means the total time, effort, or financial resources expended by persons to generate, maintain, retain, or disclose or provide information to or for a Federal Agency. This includes the time needed to review instructions; develop, acquire, install, and utilize technology and systems for the purposes of collecting, validating, and verifying information, processing and maintaining information, and disclosing and providing information; adjust the existing ways to comply with any previously applicable instructions and requirements; train personnel to be able to respond to a collection of information; search data sources; complete and review the collection of information; and transmit or otherwise disclose the information. An agency may not conduct or sponsor, and a person is not required to respond to a collection of information unless it displays a currently valid OMB control number. The OMB control numbers for EPA's regulations in 40 CFR are listed in 40 CFR part 9. When this ICR is approved by OMB, the Agency will publish a technical amendment to 40 CFR part 9 in the **Federal Register** to display the OMB control number for the approved information collection requirements contained in this final rule. C. Regulatory Flexibility Act The Regulatory Flexibility Act
(RFA)generally requires an agency to prepare a regulatory flexibility analysis of any rule subject to notice and comment rulemaking requirements under the Administrative Procedure Act or any other statute unless the agency certifies that the rule would not have a significant economic impact on a substantial number of small entities. Small entities include small businesses, small not-for-profit enterprises, and small governmental jurisdictions. For the purposes of assessing the impacts of this rule on small entities, small entity is defined as:
(1)A small business that meets the Small Business Administration size standards for small businesses found at 13 CFR 121.201;
(2)a small governmental jurisdiction that is a government of a city, county, town, school district, or special district with a population of less than 50,000; and
(3)a small organization that is any not-for-profit enterprise which is independently owned and operated and is not dominant in its field. After considering the economic impacts of this final rule on small entities, I certify that this action will not have a significant economic impact on a substantial number of small entities. The small entities directly regulated by this final rule are small businesses, small governmental jurisdictions and small non-profits. There will not be significant adverse impacts on existing area sources in any of the three source categories because the rule creates minimal burden for existing sources associated primarily with notification and reporting requirements, as the best management or equipment practices are designed to recover initial cost. EPA has determined that the cost of these requirements (estimated at less than $100 per year per facility) would not result in a significant adverse economic impact on any facility, large or small (i.e., the cost is less than one percent of total revenues, even for small businesses). Although this final rule will not have a significant economic impact on a substantial number of small entities, EPA nonetheless, has tried to reduce the impact of this rule on small entities. The standards represent practices and controls that are common throughout the sources engaged in paint stripping and surface coating. The standards also require minimal amount of recordkeeping and reporting needed to demonstrate and verify compliance. These standards were developed in consultation with numerous individual small businesses and their representative trade associations. D. Unfunded Mandates Reform Act Title II of the Unfunded Mandates Reform Act of 1995 (UMRA), Public Law 104-4, established requirements for Federal agencies to assess the effects of their regulatory actions on State, local, and tribal governments and the private sector. Under section 202 of the UMRA, EPA generally must prepare a written statement, including a cost-benefit analysis, for the proposed and final rule with “Federal mandates” that may result in expenditures to State, local, and tribal governments, in the aggregate, or to the private sector, of $100 million or more in any one year. Before promulgating a rule for which a written statement is needed, section 205 of the UMRA generally requires EPA to identify and consider a reasonable number of regulatory alternatives and adopt the least costly, most cost-effective or least burdensome alternative that achieves the objectives of the rule. The provisions of section 205 do not apply when they are inconsistent with applicable law. Moreover, section 205 allows EPA to adopt an alternative other than the least costly, most cost-effective or least burdensome alternative if the Administrator publishes with the final rule an explanation why that alternative was not adopted. Before EPA establishes any regulatory requirements that may significantly or uniquely affect small governments, including tribal governments, it must have developed under section 203 of the UMRA a small government agency plan. The plan must provide for notifying potentially affected small governments, enabling officials of affected small governments to have meaningful and timely input in the development of EPA regulatory proposals with significant Federal intergovernmental mandates, and informing, educating, and advising small governments on compliance with the regulatory requirements. EPA has determined that this rule does not contain a Federal mandate that may result in expenditures of $100 million or more for State, local, and tribal governments, in the aggregate, or the private sector in any one year. This decision is based on discussions with State, local, and tribal governments during site visits. Thus, this rule is not subject to the requirements of sections 202 and 205 of the UMRA. EPA has determined that this rule contains no regulatory requirements that might significantly or uniquely affect small governments. Some State, local, or tribal governments have paint stripping and/or surface coating operations (e.g., municipal fleet vehicle maintenance garages) that may be subject to the requirements of this rule. However, EPA does not believe that any of them are operated by small government entities. Small government entities are expected to contract for vehicle refinishing services when these services are needed, rather than doing this work in-house. In addition, total expenditures for all entities to comply with the rule are estimated to be less than $100 million in any year. E. Executive Order 13132: Federalism Executive Order
(EO)13132, entitled “Federalism” (64 FR 43255, August 10, 1999), requires EPA to develop an accountable process to ensure “meaningful and timely input by State and local officials in the development of regulatory policies that have Federalism implications”. “Policies that have Federalism implications” is defined in the EO to include regulations that have “substantial direct effects on the States, on the relationship between the national Government and the States, or on the distribution of power and responsibilities among the various levels of government.” This rule does not have Federalism implications. It will not have substantial direct effects on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government, as specified in EO 13132. The EPA is required by CAA section 112, to establish the standards in the rule. The rule primarily affects private industry, and does not impose significant economic costs on State or local governments. In the spirit of Executive Order 13132, and consistent with EPA policy to promote communications between EPA and State and local governments, EPA specifically solicited comment on the proposed rule from State and local officials. F. Executive Order 13175: Consultation and Coordination With Indian Tribal Governments Executive Order
(EO)13175, entitled “Consultation and Coordination with Indian Tribal Governments” (65 FR 67249, November 9, 2000), requires EPA to develop an accountable process to ensure “meaningful and timely input by tribal officials in the development of regulatory policies that have tribal implications.” This final rule does not have tribal implications, as specified in EO 13175. It will not have substantial direct effects on tribal governments, or the relationship between the Federal government and Indian tribes, or on the distribution of power and responsibilities between the Federal government and Indian tribes, as specified in EO 13175. Thus, EO 13175 does not apply to this rule. G. Executive Order 13045: Protection of Children From Environmental Health and Safety Risks Executive Order
(EO)13045: “Protection of Children From Environmental Health and Safety Risks” (62 FR 19885, April 23, 1997) applies to any rule that:
(1)Is determined to be “economically significant” as defined under EO 12866, and
(2)concerns an environmental health or safety risk that EPA has reason to believe may have a disproportionate effect on children. If the regulatory action meets both criteria, the Agency must evaluate the environmental health or safety effects of the planned rule on children, and explain why the planned regulation is preferable to other potentially effective and reasonably feasible alternatives considered by the Agency. EPA interprets EO 13045 as applying only to those regulatory actions that are based on health or safety risks, such that the analysis required under section 5-501 of the Order has the potential to influence the regulation. This rule is not subject to EO 13045 because it is based on technology performance and not on health or safety risks. H. Executive Order 13211: Actions Concerning Regulations That Significantly Affect Energy Supply, Distribution, or Use This rule is not a “significant energy action” as defined in Executive Order 13211, “Actions Concerning Regulations That Significantly Affect Energy Supply, Distribution, or Use” (66 FR 28355, (May 22, 2001)) because it is not likely to have a significant adverse effect on the supply, distribution, or use of energy. Some of the affected sources would be expected to install and operate spray booths to comply with the rule and these would require electricity and natural gas to operate. However the increased use of energy by these sources would not have a significant effect on the supply, distribution, or use of energy. I. National Technology Transfer Advancement Act As noted in the proposed rule, section 12(d) of the National Technology Transfer and Advancement Act of 1995 (NTTAA) (Pub. L. 104-113, 12(d), (15 U.S.C. 272 note) directs EPA to use voluntary consensus standards
(VCS)in its regulatory activities, unless to do so would be inconsistent with applicable law or otherwise impractical. The VCS are technical standards (e.g., materials specifications, test methods, sampling procedures, and business practices) that are developed or adopted by VCS bodies. The NTTAA directs EPA to provide Congress, through OMB, explanations when the Agency decides not to use available and applicable VCS. This rulemaking involves technical standards. Therefore the EPA conducted searches to identify potential voluntary consensus standards. However, we identified no such standards and none were brought to our attention in comments. The search and review results are in the docket for this rule. Therefore EPA has decided to use the following:
(1)the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) Method 52.1, “Gravimetric and Dust-Spot Procedures for Testing Air-Cleaning Devices Used in General Ventilation for Removing Particulate Matter, June 4, 1992,” to measure paint booth filter efficiency to measure the capture efficiency of paint overspray arrestors with spray-applied coatings
(2)California South Coast Air Quality Management District's (SCAQMD) methods: “Spray Equipment Transfer Efficiency Test Procedure For Equipment User, May 24, 1989” and “Guidelines for Demonstrating Equivalency with District Approved Transfer Efficient Spray Guns, September 26, 2002” as methods to demonstrate the equivalency of spray gun transfer efficiency for spray guns that do not meet the definition of HVLP or electrostatic spray. Under § 63.7(f) and § 63.8(f) of subpart A of the General Provisions, a source may apply to EPA for permission to use alternative test methods or alternative monitoring requirements in place of any required testing methods, performance specifications, or procedures. J. Executive Order 12898: Federal Actions To Address Environmental Justice in Minority Populations and Low-Income Populations Executive Order 12898 (59 FR 7629 (Feb. 16, 1994)) establishes Federal executive policy on environmental justice. Its main provision directs Federal agencies, to the greatest extent practicable and permitted by law, to make environmental justice part of their mission by identifying and addressing, as appropriate, disproportionately high and adverse human health or environmental effects of their programs, policies, and activities on minority populations and low-income populations in the United States. EPA has determined that this final rule will not have disproportionately high and adverse human health or environmental effects on minority or low-income populations because it increases the level of environmental protection for all affected populations without having any disproportionately high and adverse human health or environmental effects on any population, including any minority or low-income population. The rule establishes national standards for air quality that apply equally to all affected sources, whether or not they are located in or near minority or low-income populations. Hence there are no requirements in this rule that would disproportionately affect these populations. K. Congressional Review Act The Congressional Review Act, 5 U.S.C. 801, *et seq.* , as added by the Small Business Regulatory Enforcement Fairness Act of 1996, generally provides that before a rule may take effect the agency promulgating the rule must submit a rule report, which includes a copy of the rule, to each House of the Congress and to the Comptroller General of the United States. The EPA will submit a report containing this final rule and other required information to the U.S. Senate, the U.S. House of Representatives, and the Comptroller General of the United States prior to publication of the final rule in the **Federal Register** . A major rule cannot take effect until 60 days after it is published in the **Federal Register** . This action is not a “major rule” as defined by 5 U.S.C. 804(2). This final rule will be effective on January 9, 2008. List of Subjects in 40 CFR Part 63 Environmental protection, Air pollution control, Hazardous substances, Incorporation by reference, Reporting and recordkeeping requirements. Dated: December 14, 2007. Stephen L. Johnson, Administrator. For the reasons stated in the preamble, title 40, chapter I of the Code of Federal Regulations is amended as follows: PART 63—[AMENDED] 1. The authority citation for part 63 continues to read as follows: Authority: 42 U.S.C. 7401, *et seq.* Subpart A—[Amended] 2. Section 63.14 is amended by revising paragraph
(d)introductory text and adding new paragraphs (d)(7) and (d)(8) and (l)(1) to read as follows: § 63.14 Incorporations by reference.
(d)*State and Local Requirements.* The materials listed below are available at the Air and Radiation Docket and Information Center, U.S. EPA, 401 M St., SW., Washington, DC. Additionally, the California South Coast Air Quality Management District materials are available at *http://www.aqmd.gov/permit/spraytransferefficiency.html.*
(7)California South Coast Air Quality Management District's “Spray Equipment Transfer Efficiency Test Procedure for Equipment User, May 24, 1989”, IBR approved for § 63.11173(e)(3).
(8)California South Coast Air Quality Management District's “Guidelines for Demonstrating Equivalency with District Approved Transfer Efficient Spray Guns, September 26, 2002”, IBR approved for § 63.11173(e)(3).
(l)The following materials are available for purchase from the American Society of Heating, Refrigerating, and Air-Conditioning Engineers at 1791 Tullie Circle, NE., Atlanta, GA 30329 or by electronic mail at *orders@ashrae.org:*
(1)American Society of Heating, Refrigerating, and Air-Conditioning Engineers Method 52.1, “Gravimetric and Dust-Spot Procedures for Testing Air-Cleaning Devices Used in General Ventilation for Removing Particulate Matter, June 4, 1992”, IBR approved for § 63.11173(e)(2)(i). 3. Part 63 is amended by adding subpart HHHHHH consisting of §§ 63.11169 through 63.11180 and table 1 to read as follows: Subpart HHHHHH National Emission Standards for Hazardous Air Pollutants: Paint Stripping and Miscellaneous Surface Coating Operations at Area Sources What This Subpart Covers Sec. 63.11169 What is the purpose of this subpart? 63.11170 Am I subject to this subpart? 63.11171 How do I know if my source is considered a new source or an existing source? General Compliance Requirements 63.11172 When do I have to comply with this subpart? 63.11173 What are my general requirements for complying with this subpart? 63.11174 What parts of the General Provisions apply to me? Notifications, Reports, and Records 63.11175 What notifications must I submit? 63.11176 What reports must I submit? 63.11177 What records must I keep? 63.11178 In what form and for how long must I keep my records? Other Requirements and Information 63.11179 Who implements and enforces this subpart? 63.11180 What definitions do I need to know? Table to Subpart HHHHHH of Part 63 Table 1 to Subpart HHHHHH of Part 63—Applicability of General Provisions to Subpart HHHHHH of Part 63 Subpart HHHHHH—National Emission Standards for Hazardous Air Pollutants: Paint Stripping and Miscellaneous Surface Coating Operations at Area Sources What This Subpart Covers § 63.11169 What is the purpose of this subpart? Except as provided in paragraph
(d)of this section, this subpart establishes national emission standards for hazardous air pollutants
(HAP)for area sources involved in any of the activities in paragraphs
(a)through
(c)of this section. This subpart also establishes requirements to demonstrate initial and continuous compliance with the emission standards contained herein.
(a)Paint stripping operations that involve the use of chemical strippers that contain methylene chloride (MeCl), Chemical Abstract Service number 75092, in paint removal processes;
(b)Autobody refinishing operations that encompass motor vehicle and mobile equipment spray-applied surface coating operations;
(c)Spray application of coatings containing compounds of chromium (Cr), lead (Pb), manganese (Mn), nickel (Ni), or cadmium (Cd), collectively referred to as the target HAP to any part or product made of metal or plastic, or combinations of metal and plastic that are not motor vehicles or mobile equipment.
(d)This subpart does not apply to any of the activities described in paragraph (d)(1) through
(6)of this section.
(1)Surface coating or paint stripping performed on site at installations owned or operated by the Armed Forces of the United States (including the Coast Guard and the National Guard of any such State), the National Aeronautics and Space Administration, or the National Nuclear Security Administration.
(2)Surface coating or paint stripping of military munitions, as defined in § 63.11180, manufactured by or for the Armed Forces of the United States (including the Coast Guard and the National Guard of any such State) or equipment directly and exclusively used for the purposes of transporting military munitions.
(3)Surface coating or paint stripping performed by individuals on their personal vehicles, possessions, or property, either as a hobby or for maintenance of their personal vehicles, possessions, or property. This subpart also does not apply when these operations are performed by individuals for others without compensation. An individual who spray applies surface coating to more than two motor vehicles or pieces of mobile equipment per year is subject to the requirements in this subpart that pertain to motor vehicle and mobile equipment surface coating regardless of whether compensation is received.
(4)Surface coating or paint stripping that meets the definition of “research and laboratory activities” in § 63.11180.
(5)Surface coating or paint stripping that meets the definition of “quality control activities” in § 63.11180.
(6)Surface coating or paint stripping activities that are covered under another area source NESHAP. § 63.11170 Am I subject to this subpart?
(a)You are subject to this subpart if you operate an area source of HAP as defined in paragraph
(b)of this section, including sources that are part of a tribal, local, State, or Federal facility and you perform one or more of the activities in paragraphs (a)(1) through
(3)of this section:
(1)Perform paint stripping using MeCl for the removal of dried paint (including, but not limited to, paint, enamel, varnish, shellac, and lacquer) from wood, metal, plastic, and other substrates.
(2)Perform spray application of coatings, as defined in § 63.11180, to motor vehicles and mobile equipment including operations that are located in stationary structures at fixed locations, and mobile repair and refinishing operations that travel to the customer's location, except spray coating applications that meet the definition of facility maintenance in § 63.11180. However, if you are the owner or operator of a motor vehicle or mobile equipment surface coating operation, you may petition the Administrator for an exemption from this subpart if you can demonstrate, to the satisfaction of the Administrator, that you spray apply no coatings that contain the target HAP, as defined in § 63.11180. Petitions must include a description of the coatings that you spray apply and your certification that you do not spray apply any coatings containing the target HAP. If circumstances change such that you intend to spray apply coatings containing the target HAP, you must submit the initial notification required by 63.11175 and comply with the requirements of this subpart.
(3)Perform spray application of coatings that contain the target HAP, as defined in § 63.11180, to a plastic and/or metal substrate on a part or product, except spray coating applications that meet the definition of facility maintenance or space vehicle in § 63.11180.
(b)An area source of HAP is a source of HAP that is not a major source of HAP, is not located at a major source, and is not part of a major source of HAP emissions. A major source of HAP emissions is any stationary source or group of stationary sources located within a contiguous area and under common control that emits or has the potential to emit any single HAP at a rate of 9.07 megagrams
(Mg)(10 tons) or more per year, or emit any combination of HAP at a rate of 22.68 Mg (25 tons) or more per year. § 63.11171 How do I know if my source is considered a new source or an existing source?
(a)This subpart applies to each new and existing affected area source engaged in the activities listed in § 63.11170, with the exception of those activities listed in § 63.11169(d) of this subpart.
(b)The affected source is the collection of all of the items listed in paragraphs (b)(1) through
(6)of this section. Not all affected sources will have all of the items listed in paragraphs (b)(1) through
(6)of this section.
(1)Mixing rooms and equipment;
(2)Spray booths, ventilated prep stations, curing ovens, and associated equipment;
(3)Spray guns and associated equipment;
(4)Spray gun cleaning equipment;
(5)Equipment used for storage, handling, recovery, or recycling of cleaning solvent or waste paint; and
(6)Equipment used for paint stripping at paint stripping facilities using paint strippers containing MeCl.
(c)An affected source is a new source if it meets the criteria in paragraphs (c)(1) and (c)(2) of this section.
(1)You commenced the construction of the source after September 17, 2007 by installing new paint stripping or surface coating equipment. If you purchase and install spray booths, enclosed spray gun cleaners, paint stripping equipment to reduce MeCl emissions, or purchase new spray guns to comply with this subpart at an existing source, these actions would not make your existing source a new source.
(2)The new paint stripping or surface coating equipment is used at a source that was not actively engaged in paint stripping and/or miscellaneous surface coating prior to September 17, 2007.
(d)An affected source is reconstructed if it meets the definition of reconstruction in § 63.2.
(e)An affected source is an existing source if it is not a new source or a reconstructed source. General Compliance Requirements § 63.11172 When do I have to comply with this subpart? The date by which you must comply with this subpart is called the compliance date. The compliance date for each type of affected source is specified in paragraphs
(a)and
(b)of this section.
(a)For a new or reconstructed affected source, the compliance date is the applicable date in paragraph (a)(1) or
(2)of this section:
(1)If the initial startup of your new or reconstructed affected source is after September 17, 2007, the compliance date is January 9, 2008.
(2)If the initial startup of your new or reconstructed affected source occurs after January 9, 2008, the compliance date is the date of initial startup of your affected source.
(b)For an existing affected source, the compliance date is January 10, 2011. § 63.11173 What are my general requirements for complying with this subpart?
(a)Each paint stripping operation that is an affected area source must implement management practices to minimize the evaporative emissions of MeCl. The management practices must address, at a minimum, the practices in paragraphs (a)(1) through
(5)of this section, as applicable, for your operations.
(1)Evaluate each application to ensure there is a need for paint stripping (e.g., evaluate whether it is possible to re-coat the piece without removing the existing coating).
(2)Evaluate each application where a paint stripper containing MeCl is used to ensure that there is no alternative paint stripping technology that can be used.
(3)Reduce exposure of all paint strippers containing MeCl to the air.
(4)Optimize application conditions when using paint strippers containing MeCl to reduce MeCl evaporation (e.g., if the stripper must be heated, make sure that the temperature is kept as low as possible to reduce evaporation).
(5)Practice proper storage and disposal of paint strippers containing MeCl (e.g., store stripper in closed, air-tight containers).
(b)Each paint stripping operation that has annual usage of more than one ton of MeCl must develop and implement a written MeCl minimization plan to minimize the use and emissions of MeCl. The MeCl minimization plan must address, at a minimum, the management practices specified in paragraphs (a)(1) through
(5)of this section, as applicable, for your operations. Each operation must post a placard or sign outlining the MeCl minimization plan in each area where paint stripping operations subject to this subpart occur. Paint stripping operations with annual usage of more than one ton of MeCl, must comply with the management practices in paragraphs (a)(1) through
(5)of this section, as applicable, but are not required to develop and implement a written MeCl minimization plan.
(c)Each paint stripping operation must maintain copies of annual usage of paint strippers containing MeCl on site at all times.
(d)Each paint stripping operation with annual usage of more than one ton of MeCl must maintain a copy of their current MeCl minimization plan on site at all times.
(e)Each motor vehicle and mobile equipment surface coating operation and each miscellaneous surface coating operation must meet the requirements in paragraphs (e)(1) through (e)(5) of this section.
(1)All painters must be certified that they have completed training in the proper spray application of surface coatings and the proper setup and maintenance of spray equipment. The minimum requirements for training and certification are described in paragraph
(f)of this section. The spray application of surface coatings is prohibited by persons who are not certified as having completed the training described in paragraph
(f)of this section. The requirements of this paragraph do not apply to the students of an accredited surface coating training program who are under the direct supervision of an instructor who meets the requirements of this paragraph.
(2)All spray-applied coatings must be applied in a spray booth, preparation station, or mobile enclosure that meets the requirements of paragraph (e)(2)(i) of this section and either paragraph (e)(2)(ii), (e)(2)(iii), or (e)(2)(iv) of this section.
(i)All spray booths, preparation stations, and mobile enclosures must be fitted with a type of filter technology that is demonstrated to achieve at least 98-percent capture of paint overspray. The procedure used to demonstrate filter efficiency must be consistent with the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) Method 52.1, “Gravimetric and Dust-Spot Procedures for Testing Air-Cleaning Devices Used in General Ventilation for Removing Particulate Matter, June 4, 1992” (incorporated by reference, see § 63.14 of subpart A of this part). The test coating for measuring filter efficiency shall be a high solids bake enamel delivered at a rate of at least 135 grams per minute from a conventional (non-HVLP) air-atomized spray gun operating at 40 pounds per square inch
(psi)air pressure; the air flow rate across the filter shall be 150 feet per minute. Owners and operators may use published filter efficiency data provided by filter vendors to demonstrate compliance with this requirement and are not required to perform this measurement. The requirements of this paragraph do not apply to waterwash spray booths that are operated and maintained according to the manufacturer's specifications.
(ii)Spray booths and preparation stations used to refinish complete motor vehicles or mobile equipment must be fully enclosed with a full roof, and four complete walls or complete side curtains, and must be ventilated at negative pressure so that air is drawn into any openings in the booth walls or preparation station curtains. However, if a spray booth is fully enclosed and has seals on all doors and other openings and has an automatic pressure balancing system, it may be operated at up to, but not more than, 0.05 inches water gauge positive pressure.
(iii)Spray booths and preparation stations that are used to coat miscellaneous parts and products or vehicle subassemblies must have a full roof, at least three complete walls or complete side curtains, and must be ventilated so that air is drawn into the booth. The walls and roof of a booth may have openings, if needed, to allow for conveyors and parts to pass through the booth during the coating process.
(iv)Mobile ventilated enclosures that are used to perform spot repairs must enclose and, if necessary, seal against the surface around the area being coated such that paint overspray is retained within the enclosure and directed to a filter to capture paint overspray.
(3)All spray-applied coatings must be applied with a high volume, low pressure
(HVLP)spray gun, electrostatic application, airless spray gun, air-assisted airless spray gun, or an equivalent technology that is demonstrated by the spray gun manufacturer to achieve transfer efficiency comparable to one of the spray gun technologies listed above for a comparable operation, and for which written approval has been obtained from the Administrator. The procedure used to demonstrate that spray gun transfer efficiency is equivalent to that of an HVLP spray gun must be equivalent to the California South Coast Air Quality Management District's “Spray Equipment Transfer Efficiency Test Procedure for Equipment User, May 24, 1989” and “Guidelines for Demonstrating Equivalency with District Approved Transfer Efficient Spray Guns, September 26, 2002” (incorporated by reference, see § 63.14 of subpart A of this part). The requirements of this paragraph do not apply to painting performed by students and instructors at paint training centers. The requirements of this paragraph do not apply to the surface coating of aerospace vehicles that involves the coating of components that normally require the use of an airbrush or an extension on the spray gun to properly reach limited access spaces; to the application of coatings on aerospace vehicles that contain fillers that adversely affect atomization with HVLP spray guns; or to the application of coatings on aerospace vehicles that normally have a dried film thickness of less than 0.0013 centimeter (0.0005 in.).
(4)All paint spray gun cleaning must be done so that an atomized mist or spray of gun cleaning solvent and paint residue is not created outside of a container that collects used gun cleaning solvent. Spray gun cleaning may be done with, for example, hand cleaning of parts of the disassembled gun in a container of solvent, by flushing solvent through the gun without atomizing the solvent and paint residue, or by using a fully enclosed spray gun washer. A combination of non-atomizing methods may also be used.
(5)As provided in § 63.6(g), we, the U.S. Environmental Protection Agency, may choose to grant you permission to use an alternative to the emission standards in this section after you have requested approval to do so according to § 63.6(g)(2).
(f)Each owner or operator of an affected miscellaneous surface coating source must ensure and certify that all new and existing personnel, including contract personnel, who spray apply surface coatings, as defined in § 63.11180, are trained in the proper application of surface coatings as required by paragraph (e)(1) of this section. The training program must include, at a minimum, the items listed in paragraphs (f)(1) through (f)(3) of this section.
(1)A list of all current personnel by name and job description who are required to be trained;
(2)Hands-on and classroom instruction that addresses, at a minimum, initial and refresher training in the topics listed in paragraphs (f)(2)(i) through (2)(iv) of this section.
(i)Spray gun equipment selection, set up, and operation, including measuring coating viscosity, selecting the proper fluid tip or nozzle, and achieving the proper spray pattern, air pressure and volume, and fluid delivery rate.
(ii)Spray technique for different types of coatings to improve transfer efficiency and minimize coating usage and overspray, including maintaining the correct spray gun distance and angle to the part, using proper banding and overlap, and reducing lead and lag spraying at the beginning and end of each stroke.
(iii)Routine spray booth and filter maintenance, including filter selection and installation.
(iv)Environmental compliance with the requirements of this subpart.
(3)A description of the methods to be used at the completion of initial or refresher training to demonstrate, document, and provide certification of successful completion of the required training. Owners and operators who can show by documentation or certification that a painter's work experience and/or training has resulted in training equivalent to the training required in paragraph (f)(2) of this section are not required to provide the initial training required by that paragraph to these painters.
(g)As required by paragraph (e)(1) of this section, all new and existing personnel at an affected motor vehicle and mobile equipment or miscellaneous surface coating source, including contract personnel, who spray apply surface coatings, as defined in § 63.11180, must be trained by the dates specified in paragraphs (g)(1) and
(2)of this section. Employees who transfer within a company to a position as a painter are subject to the same requirements as a new hire.
(1)If your source is a new source, all personnel must be trained and certified no later than 180 days after hiring or no later than July 7, 2008, whichever is later. Painter training that was completed within five years prior to the date training is required, and that meets the requirements specified in paragraph (f)(2) of this section satisfies this requirement and is valid for a period not to exceed five years after the date the training is completed.
(2)If your source is an existing source, all personnel must be trained and certified no later than 180 days after hiring or no later than January 10, 2011, whichever is later. Painter training that was completed within five years prior to the date training is required, and that meets the requirements specified in paragraph (f)(2) of this section satisfies this requirement and is valid for a period not to exceed five years after the date the training is completed.
(3)Training and certification will be valid for a period not to exceed five years after the date the training is completed, and all personnel must receive refresher training that meets the requirements of this section and be re-certified every five years. § 63.11174 What parts of the General Provisions apply to me?
(a)Table 1 of this subpart shows which parts of the General Provisions in subpart A apply to you.
(b)If you are an owner or operator of an area source subject to this subpart, you are exempt from the obligation to obtain a permit under 40 CFR part 70 or 71, provided you are not required to obtain a permit under 40 CFR 70.3(a) or 71.3(a) for a reason other than your status as an area source under this subpart. Notwithstanding the previous sentence, you must continue to comply with the provisions of this subpart applicable to area sources. Notifications, Reports, and Records § 63.11175 What notifications must I submit?
(a)Initial Notification. If you are the owner or operator of a paint stripping operation using paint strippers containing MeCl and/or a surface coating operation subject to this subpart, you must submit the initial notification required by § 63.9(b). For a new affected source, you must submit the Initial Notification no later than 180 days after initial startup or July 7, 2008, whichever is later. For an existing affected source, you must submit the initial notification no later than January 11, 2010. The initial notification must provide the information specified in paragraphs (a)(1) through
(8)of this section.
(1)The company name, if applicable.
(2)The name, title, street address, telephone number, e-mail address (if available), and signature of the owner and operator, or other certifying company official;
(3)The street address (physical location) of the affected source and the street address where compliance records are maintained, if different. If the source is a motor vehicle or mobile equipment surface coating operation that repairs vehicles at the customer's location, rather than at a fixed location, such as a collision repair shop, the notification should state this and indicate the physical location where records are kept to demonstrate compliance;
(4)An identification of the relevant standard (i.e., this subpart, 40 CFR part 63, subpart HHHHHH);
(5)A brief description of the type of operation as specified in paragraph (a)(5)(i) or
(ii)of this section.
(i)For all surface coating operations, indicate whether the source is a motor vehicle and mobile equipment surface coating operation or a miscellaneous surface coating operation, and include the number of spray booths and preparation stations, and the number of painters usually employed at the operation.
(ii)For paint stripping operations, identify the method(s) of paint stripping employed (e.g., chemical, mechanical) and the substrates stripped (e.g., wood, plastic, metal).
(6)Each paint stripping operation must indicate whether they plan to annually use more than one ton of MeCl after the compliance date.
(7)A statement of whether the source is already in compliance with each of the relevant requirements of this subpart, or whether the source will be brought into compliance by the compliance date. For paint stripping operations, the relevant requirements that you must evaluate in making this determination are specified in § 63.11173(a) through
(d)of this subpart. For surface coating operations, the relevant requirements are specified in § 63.11173(e) through
(g)of this subpart.
(8)If your source is a new source, you must certify in the initial notification whether the source is in compliance with each of the requirements of this subpart. If your source is an existing source, you may certify in the initial notification that the source is already in compliance. If you are certifying in the initial notification that the source is in compliance with the relevant requirements of this subpart, then include also a statement by a responsible official with that official's name, title, phone number, e-mail address (if available) and signature, certifying the truth, accuracy, and completeness of the notification, a statement that the source has complied with all the relevant standards of this subpart, and that this initial notification also serves as the notification of compliance status.
(b)Notification of Compliance Status. If you are the owner or operator of a new source, you are not required to submit a separate notification of compliance status in addition to the initial notification specified in paragraph
(a)of this subpart provided you were able to certify compliance on the date of the initial notification, as part of the initial notification, and your compliance status has not since changed. If you are the owner or operator of any existing source and did not certify in the initial notification that your source is already in compliance as specified in paragraph
(a)of this section, then you must submit a notification of compliance status. You must submit a Notification of Compliance Status on or before March 11, 2011. You are required to submit the information specified in paragraphs (b)(1) through
(4)of this section with your Notification of Compliance Status:
(1)Your company's name and the street address (physical location) of the affected source and the street address where compliance records are maintained, if different.
(2)The name, title, address, telephone, e-mail address (if available) and signature of the owner and operator, or other certifying company official, certifying the truth, accuracy, and completeness of the notification and a statement of whether the source has complied with all the relevant standards and other requirements of this subpart or an explanation of any noncompliance and a description of corrective actions being taken to achieve compliance. For paint stripping operations, the relevant requirements that you must evaluate in making this determination are specified in § 63.11173(a) through (d). For surface coating operations, the relevant requirements are specified in § 63.11173(e) through (g).
(3)The date of the Notification of Compliance Status.
(4)If you are the owner or operator of an existing affected paint stripping source that annually uses more than one ton of MeCl, you must submit a statement certifying that you have developed and are implementing a written MeCl minimization plan in accordance with § 63.11173(b). § 63.11176 What reports must I submit?
(a)Annual Notification of Changes Report. If you are the owner or operator of a paint stripping, motor vehicle or mobile equipment, or miscellaneous surface coating affected source, you are required to submit a report in each calendar year in which information previously submitted in either the initial notification required by § 63.11175(a), Notification of Compliance, or a previous annual notification of changes report submitted under this paragraph, has changed. Deviations from the relevant requirements in § 63.11173(a) through
(d)or § 63.11173(e) through
(g)on the date of the report will be deemed to be a change. This includes notification when paint stripping affected sources that have not developed and implemented a written MeCl minimization plan in accordance with § 63.11173(b) used more than one ton of MeCl in the previous calendar year. The annual notification of changes report must be submitted prior to March 1 of each calendar year when reportable changes have occurred and must include the information specified in paragraphs (a)(1) through
(2)of this section.
(1)Your company's name and the street address (physical location) of the affected source and the street address where compliance records are maintained, if different.
(2)The name, title, address, telephone, e-mail address (if available) and signature of the owner and operator, or other certifying company official, certifying the truth, accuracy, and completeness of the notification and a statement of whether the source has complied with all the relevant standards and other requirements of this subpart or an explanation of any noncompliance and a description of corrective actions being taken to achieve compliance.
(b)If you are the owner or operator of a paint stripping affected source that has not developed and implemented a written MeCl minimization plan in accordance with § 63.11173(b) of this subpart, you must submit a report for any calendar year in which you use more than one ton of MeCl. This report must be submitted no later than March 1 of the following calendar year. You must also develop and implement a written MeCl minimization plan in accordance with § 63.11173(b) no later than December 31. You must then submit a Notification of Compliance Status report containing the information specified in § 63.11175(b) by March 1 of the following year and comply with the requirements for paint stripping operations that annually use more than one ton of MeCl in §§ 63.11173(d) and 63.11177(f). § 63.11177 What records must I keep? If you are the owner or operator of a surface coating operation, you must keep the records specified in paragraphs
(a)through
(d)and
(g)of this section. If you are the owner or operator of a paint stripping operation, you must keep the records specified in paragraphs
(e)through
(g)of this section, as applicable.
(a)Certification that each painter has completed the training specified in § 63.11173(f) with the date the initial training and the most recent refresher training was completed.
(b)Documentation of the filter efficiency of any spray booth exhaust filter material, according to the procedure in § 63.11173(e)(3)(i).
(c)Documentation from the spray gun manufacturer that each spray gun with a cup capacity equal to or greater than 3.0 fluid ounces (89 cc) that does not meet the definition of an HVLP spray gun, electrostatic application, airless spray gun, or air assisted airless spray gun, has been determined by the Administrator to achieve a transfer efficiency equivalent to that of an HVLP spray gun, according to the procedure in § 63.11173(e)(4).
(d)Copies of any notification submitted as required by § 63.11175 and copies of any report submitted as required by § 63.11176.
(e)Records of paint strippers containing MeCl used for paint stripping operations, including the MeCl content of the paint stripper used. Documentation needs to be sufficient to verify annual usage of paint strippers containing MeCl (e.g., material safety data sheets or other documentation provided by the manufacturer or supplier of the paint stripper, purchase receipts, records of paint stripper usage, engineering calculations).
(f)If you are a paint stripping source that annually uses more than one ton of MeCl you are required to maintain a record of your current MeCl minimization plan on site for the duration of your paint stripping operations. You must also keep records of your annual review of, and updates to, your MeCl minimization plan.
(g)Records of any deviation from the requirements in §§ 63.11173, 63.11174, 63.11175, or 63.11176. These records must include the date and time period of the deviation, and a description of the nature of the deviation and the actions taken to correct the deviation.
(h)Records of any assessments of source compliance performed in support of the initial notification, notification of compliance status, or annual notification of changes report. § 63.11178 In what form and for how long must I keep my records?
(a)If you are the owner or operator of an affected source, you must maintain copies of the records specified in § 63.11177 for a period of at least five years after the date of each record. Copies of records must be kept on site and in a printed or electronic form that is readily accessible for inspection for at least the first two years after their date, and may be kept off-site after that two year period. Other Requirements and Information § 63.11179 Who implements and enforces this subpart?
(a)This subpart can be implemented and enforced by us, the U.S. Environmental Protection Agency (EPA), or a delegated authority such as your State, local, or tribal agency. If the Administrator has delegated authority to your State, local, or tribal agency, then that agency (as well as the EPA) has the authority to implement and enforce this subpart. You should contact your EPA Regional Office to find out if implementation and enforcement of this subpart is delegated to your State, local, or tribal agency.
(b)In delegating implementation and enforcement authority of this subpart to a State, local, or tribal agency under subpart E of this part, the authorities contained in paragraph
(c)of this section are retained by the Administrator and are not transferred to the State, local, or tribal agency.
(c)The authority in § 63.11173(e)(5) will not be delegated to State, local, or tribal agencies. § 63.11180 What definitions do I need to know? Terms used in this subpart are defined in the Clean Air Act, in 40 CFR 63.2, and in this section as follows: *Additive* means a material that is added to a coating after purchase from a supplier (e.g., catalysts, activators, accelerators). *Administrator* means, for the purposes of this rulemaking, the Administrator of the U.S. Environmental Protection Agency or the State or local agency that is granted delegation for implementation of this subpart. *Aerospace vehicle or component* means any fabricated part, processed part, assembly of parts, or completed unit, with the exception of electronic components, of any aircraft including but not limited to airplanes, helicopters, missiles, rockets, and space vehicles. *Airless and air-assisted airless spray* mean any paint spray technology that relies solely on the fluid pressure of the paint to create an atomized paint spray pattern and does not apply any atomizing compressed air to the paint before it leaves the paint nozzle. Air-assisted airless spray uses compressed air to shape and distribute the fan of atomized paint, but still uses fluid pressure to create the atomized paint. *Appurtenance* means any accessory to a stationary structure coated at the site of installation, whether installed or detached, including but not limited to: bathroom and kitchen fixtures; cabinets; concrete forms; doors; elevators; fences; hand railings; heating equipment, air conditioning equipment, and other fixed mechanical equipment or stationary tools; lamp posts; partitions; pipes and piping systems; rain gutters and downspouts; stairways, fixed ladders, catwalks, and fire escapes; and window screens. *Architectural coating* means a coating to be applied to stationary structures or their appurtenances at the site of installation, to portable buildings at the site of installation, to pavements, or to curbs. *Cleaning material* means a solvent used to remove contaminants and other materials, such as dirt, grease, or oil, from a substrate before or after coating application or from equipment associated with a coating operation, such as spray booths, spray guns, racks, tanks, and hangers. Thus, it includes any cleaning material used on substrates or equipment or both. *Coating* means, for the purposes of this subpart, a material spray-applied to a substrate for decorative, protective, or functional purposes. For the purposes of this subpart, coating does not include the following materials:
(1)Decorative, protective, or functional materials that consist only of protective oils for metal, acids, bases, or any combination of these substances.
(2)Paper film or plastic film that may be pre-coated with an adhesive by the film manufacturer.
(3)Adhesives, sealants, maskants, or caulking materials.
(4)Temporary protective coatings, lubricants, or surface preparation materials.
(5)In-mold coatings that are spray-applied in the manufacture of reinforced plastic composite parts. *Compliance date* means the date by which you must comply with this subpart. *Deviation* means any instance in which an affected source, subject to this subpart, or an owner or operator of such a source fails to meet any requirement or obligation established by this subpart. *Dry media blasting* means abrasive blasting using dry media. Dry media blasting relies on impact and abrasion to remove paint from a substrate. Typically, a compressed air stream is used to propel the media against the coated surface. *Electrostatic application* means any method of coating application where an electrostatic attraction is created between the part to be coated and the atomized paint particles. *Equipment cleaning* means the use of an organic solvent to remove coating residue from the surfaces of paint spray guns and other painting related equipment, including, but not limited to stir sticks, paint cups, brushes, and spray booths. *Facility maintenance* means, for the purposes of this subpart, surface coating performed as part of the routine repair or renovation of the tools, equipment, machinery, and structures that comprise the infrastructure of the affected facility and that are necessary for the facility to function in its intended capacity. *Facility maintenance* also includes surface coating associated with the installation of new equipment or structures, and the application of any surface coating as part of janitorial activities. *Facility maintenance* includes the application of coatings to stationary structures or their appurtenances at the site of installation, to portable buildings at the site of installation, to pavements, or to curbs. *Facility maintenance* also includes the refinishing of mobile equipment in the field or at the site where they are used in service and at which they are intended to remain indefinitely after refinishing. Such mobile equipment includes, but is not limited to, farm equipment and mining equipment for which it is not practical or feasible to move to a dedicated mobile equipment refinishing facility. Such mobile equipment also includes items, such as fork trucks, that are used in a manufacturing facility and which are refinished in that same facility. *Facility maintenance* does not include surface coating of motor vehicles, mobile equipment, or items that routinely leave and return to the facility, such as delivery trucks, rental equipment, or containers used to transport, deliver, distribute, or dispense commercial products to customers, such as compressed gas canisters. *High-volume, low-pressure
(HVLP)spray equipment* means spray equipment that is permanently labeled as such and used to apply any coating by means of a spray gun which is designed and operated between 0.1 and 10 pounds per square inch gauge
(psig)air atomizing pressure measured dynamically at the center of the air cap and at the air horns. *Initial startup* means the first time equipment is brought online in a paint stripping or surface coating operation, and paint stripping or surface coating is first performed. *Materials that contain HAP* or *HAP-containing materials* mean, for the purposes of this subpart, materials that contain 0.1 percent or more by mass of any individual HAP that is an OSHA-defined carcinogen as specified in 29 CFR 1910.1200(d)(4), or 1.0 percent or more by mass for any other individual HAP. *Military munitions* means all ammunition products and components produced or used by or for the U.S. Department of Defense
(DoD)or for the U.S. Armed Services for national defense and security, including military munitions under the control of the Department of Defense, the U.S. Coast Guard, the National Nuclear Security Administration (NNSA), U.S. Department of Energy (DOE), and National Guard personnel. The term military munitions includes: confined gaseous, liquid, and solid propellants, explosives, pyrotechnics, chemical and riot control agents, smokes, and incendiaries used by DoD components, including bulk explosives and chemical warfare agents, chemical munitions, biological weapons, rockets, guided and ballistic missiles, bombs, warheads, mortar rounds, artillery ammunition, small arms ammunition, grenades, mines, torpedoes, depth charges, cluster munitions and dispensers, demolition charges, nonnuclear components of nuclear weapons, wholly inert ammunition products, and all devices and components of any items listed in this definition. *Miscellaneous parts and/or products* means any part or product made of metal or plastic, or combinations of metal and plastic. Miscellaneous parts and/or products include, but are not limited to, metal and plastic components of the following types of products as well as the products themselves: motor vehicle parts and accessories for automobiles, trucks, recreational vehicles; automobiles and light duty trucks at automobile and light duty truck assembly plants; boats; sporting and recreational goods; toys; business machines; laboratory and medical equipment; and household and other consumer products. *Miscellaneous surface coating operation* means the collection of equipment used to apply surface coating to miscellaneous parts and/or products made of metal or plastic, including applying cleaning solvents to prepare the surface before coating application, mixing coatings before application, applying coating to a surface, drying or curing the coating after application, and cleaning coating application equipment, but not plating. A single surface coating operation may include any combination of these types of equipment, but always includes at least the point at which a coating material is applied to a given part. A surface coating operation includes all other steps (such as surface preparation with solvent and equipment cleaning) in the affected source where HAP are emitted from the coating of a part. The use of solvent to clean parts (for example, to remove grease during a mechanical repair) does not constitute a miscellaneous surface coating operation if no coatings are applied. A single affected source may have multiple surface coating operations. Surface coatings applied to wood, leather, rubber, ceramics, stone, masonry, or substrates other than metal and plastic are not considered miscellaneous surface coating operations for the purposes of this subpart. *Mobile equipment* means any device that may be drawn and/or driven on a roadway including, but not limited to, heavy-duty trucks, truck trailers, fleet delivery trucks, buses, mobile cranes, bulldozers, street cleaners, agriculture equipment, motor homes, and other recreational vehicles (including camping trailers and fifth wheels). *Motor vehicle* means any self-propelled vehicle, including, but not limited to, automobiles, light duty trucks, golf carts, vans, and motorcycles. *Motor vehicle and mobile equipment surface coating* means the spray application of coatings to assembled motor vehicles or mobile equipment. For the purposes of this subpart, it does not include the surface coating of motor vehicle or mobile equipment parts or subassemblies at a vehicle assembly plant or parts manufacturing plant. *Non-HAP solvent* means, for the purposes of this subpart, a solvent (including thinners and cleaning solvents) that contains less than 0.1 percent by mass of any individual HAP that is an OSHA-defined carcinogen as specified in 29 CFR 1910.1200(d)(4) and less than 1.0 percent by mass for any other individual HAP. *Paint stripping and/or miscellaneous surface coating source or facility* means any shop, business, location, or parcel of land where paint stripping or miscellaneous surface coating operations are conducted. *Paint stripping* means the removal of dried coatings from wood, metal, plastic, and other substrates. A single affected source may have multiple paint stripping operations. *Painter* means any person who spray applies coating. *Plastic* refers to substrates containing one or more resins and may be solid, porous, flexible, or rigid. Plastics include fiber reinforced plastic composites. *Protective oil* means organic material that is applied to metal for the purpose of providing lubrication or protection from corrosion without forming a solid film. This definition of protective oil includes, but is not limited to, lubricating oils, evaporative oils (including those that evaporate completely), and extrusion oils. *Quality control activities* means surface coating or paint stripping activities that meet all of the following criteria:
(1)The activities associated with a surface coating or paint stripping operation are intended to detect and correct defects in the final product by selecting a limited number of samples from the operation, and comparing the samples against specific performance criteria.
(2)The activities do not include the production of an intermediate or final product for sale or exchange for commercial profit; for example, parts that are surface coated or stripped are not sold and do not leave the facility.
(3)The activities are not a normal part of the surface coating or paint stripping operation; for example, they do not include color matching activities performed during a motor vehicle collision repair.
(4)The activities do not involve surface coating or stripping of the tools, equipment, machinery, and structures that comprise the infrastructure of the affected facility and that are necessary for the facility to function in its intended capacity; that is, the activities are not facility maintenance. *Research and laboratory activities* means surface coating or paint stripping activities that meet one of the following criteria:
(1)Conducted at a laboratory to analyze air, soil, water, waste, or product samples for contaminants, or environmental impact.
(2)Activities conducted to test more efficient production processes, including alternative paint stripping or surface coating materials or application methods, or methods for preventing or reducing adverse environmental impacts, provided that the activities do not include the production of an intermediate or final product for sale or exchange for commercial profit.
(3)Activities conducted at a research or laboratory facility that is operated under the close supervision of technically trained personnel, the primary purpose of which is to conduct research and development into new processes and products and that is not engaged in the manufacture of products for sale or exchange for commercial profit. *Solvent* means a fluid containing organic compounds used to perform paint stripping, surface prep, or cleaning of surface coating equipment. *Space Vehicle* means vehicles designed to travel beyond the limit of the earth's atmosphere, including but not limited to satellites, space stations, and the Space Shuttle System (including orbiter, external tanks, and solid rocket boosters). *Spray-applied coating operations* means coatings that are applied using a hand-held device that creates an atomized mist of coating and deposits the coating on a substrate. For the purposes of this subpart, spray-applied coatings do not include the following materials or activities:
(1)Coatings applied from a hand-held device with a paint cup capacity that is equal to or less than 3.0 fluid ounces (89 cubic centimeters).
(2)Surface coating application using powder coating, hand-held, non-refillable aerosol containers, or non-atomizing application technology, including, but not limited to, paint brushes, rollers, hand wiping, flow coating, dip coating, electrodeposition coating, web coating, coil coating, touch-up markers, or marking pens.
(3)Thermal spray operations (also known as metallizing, flame spray, plasma arc spray, and electric arc spray, among other names) in which solid metallic or non-metallic material is heated to a molten or semi-molten state and propelled to the work piece or substrate by compressed air or other gas, where a bond is produced upon impact. *Surface preparation* or *Surface prep* means use of a cleaning material on a portion of or all of a substrate prior to the application of a coating. *Target HAP* are compounds of chromium (Cr), lead (Pb), manganese (Mn), nickel (Ni), or cadmium (Cd). *Target HAP containing coating* means a spray-applied coating that contains any individual target HAP that is an Occupational Safety and Health Administration (OSHA)-defined carcinogen as specified in 29 CFR 1910.1200(d)(4) at a concentration greater than 0.1 percent by mass, or greater than 1.0 percent by mass for any other individual target HAP compound. For the purpose of determining whether materials you use contain the target HAP compounds, you may rely on formulation data provided by the manufacturer or supplier, such as the material safety data sheet (MSDS), as long as it represents each target HAP compound in the material that is present at 0.1 percent by mass or more for OSHA-defined carcinogens as specified in 29 CFR 1910.1200(d)(4) and at 1.0 percent by mass or more for other target HAP compounds. *Transfer efficiency* means the amount of coating solids adhering to the object being coated divided by the total amount of coating solids sprayed, expressed as a percentage. Coating solids means the nonvolatile portion of the coating that makes up the dry film. *Truck bed liner coating* means any coating, excluding color coats, labeled and formulated for application to a truck bed to protect it from surface abrasion. Table 1 to Subpart HHHHHH of Part 63.—Applicability of General Provisions to Subpart HHHHHH of Part 63 Citation Subject Applicable to subpart HHHHHH Explanation § 63.1(a)(1)-(12) General Applicability Yes § 63.1(b)(1)-(3) Initial Applicability Determination Yes Applicability of subpart HHHHHH is also specified in § 63.11170. § 63.1(c)(1) Applicability After Standard Established Yes § 63.1(c)(2) Applicability of Permit Program for Area Sources Yes (63.11174(b) of Subpart HHHHHH exempts area sources from the obligation to obtain Title V operating permits. § 63.1(c)(5) Notifications Yes § 63.1(e) Applicability of Permit Program to Major Sources Before Relevant Standard is Set No (63.11174(b) of Subpart HHHHHH exempts area sources from the obligation to obtain Title V operating permits. § 63.2 Definitions Yes Additional definitions are specified in § 63.11180. § 63.3(a)-(c) Units and Abbreviations Yes § 63.4(a)(1)-(5) Prohibited Activities Yes § 63.4(b)-(c) Circumvention/Fragmentation Yes § 63.5 Construction/Reconstruction of major sources No Subpart HHHHHH applies only to area sources. § 63.6(a) Compliance With Standards and Maintenance Requirements—Applicability Yes § 63.6(b)(1)-(7) Compliance Dates for New and Reconstructed Sources Yes § 63.11172 specifies the compliance dates. § 63.6(c)(1)-(5) Compliance Dates for Existing Sources Yes § 63.11172 specifies the compliance dates. § 63.6(e)(1)-(2) Operation and Maintenance Yes § 63.6(e)(3) Startup, Shutdown, and Malfunction Plan No No startup, shutdown, and malfunction plan is required by subpart HHHHHH. § 63.6(f)(1) Compliance Except During Startup, Shutdown, and Malfunction Yes § 63.6(f)(2)-(3) Methods for Determining Compliance Yes § 63.6(g)(1)-(3) Use of an Alternative Standard Yes § 63.6(h) Compliance With Opacity/Visible Emission Standards No Subpart HHHHHH does not establish opacity or visible emission standards. § 63.6(i)(1)-(16) Extension of Compliance Yes § 63.6(j) Presidential Compliance Exemption Yes § 63.7 Performance Testing Requirements No No performance testing is required by subpart HHHHHH. § 63.8 Monitoring Requirements No Subpart HHHHHH does not require the use of continuous monitoring systems. § 63.9(a)-(d) Notification Requirements Yes § 63.11175 specifies notification requirements. § 63.9(e) Notification of Performance Test No Subpart HHHHHH does not require performance tests. § 63.9(f) Notification of Visible Emissions/Opacity Test No Subpart HHHHHH does not have opacity or visible emission standards. § 63.9(g) Additional Notifications When Using CMS No Subpart HHHHHH does not require the use of continuous monitoring systems. § 63.9(h) Notification of Compliance Status No § 63.11175 specifies the dates and required content for submitting the notification of compliance status. § 63.9(i) Adjustment of Submittal Deadlines Yes § 63.9(j) Change in Previous Information Yes § 63.11176(a) specifies the dates for submitting the notification of changes report. § 63.10(a) Recordkeeping/Reporting—Applicability and General Information Yes § 63.10(b)(1) General Recordkeeping Requirements Yes Additional requirements are specified in § 63.11177. § 63.10(b)(2)(i)-(xi) Recordkeeping Relevant to Startup, Shutdown, and Malfunction Periods and CMS No Subpart HHHHHH does not require startup, shutdown, and malfunction plans, or CMS. § 63.10(b)(2)(xii) Waiver of recordkeeping requirements Yes § 63.10(b)(2)(xiii) Alternatives to the relative accuracy test No Subpart HHHHHH does not require the use of CEMS. § 63.10(b)(2)(xiv) Records supporting notifications Yes § 63.10(b)(3) Recordkeeping Requirements for Applicability Determinations Yes § 63.10(c) Additional Recordkeeping Requirements for Sources with CMS No Subpart HHHHHH does not require the use of CMS. § 63.10(d)(1) General Reporting Requirements Yes Additional requirements are specified in § 63.11176. § 63.10(d)(2)-(3) Report of Performance Test Results, and Opacity or Visible Emissions Observations No Subpart HHHHHH does not require performance tests, or opacity or visible emissions observations. § 63.10(d)(4) Progress Reports for Sources With Compliance Extensions Yes § 63.10(d)(5) Startup, Shutdown, and Malfunction Reports No Subpart HHHHHH does not require startup, shutdown, and malfunction reports. § 63.10(e) Additional Reporting requirements for Sources with CMS No Subpart HHHHHH does not require the use of CMS. § 63.10(f) Recordkeeping/Reporting Waiver Yes § 63.11 Control Device Requirements/Flares No Subpart HHHHHH does not require the use of flares. § 63.12 State Authority and Delegations Yes § 63.13 Addresses of State Air Pollution Control Agencies and EPA Regional Offices Yes § 63.14 Incorporation by Reference Yes Test methods for measuring paint booth filter efficiency and spray gun transfer efficiency in § 63.11173(e)(2) and
(3)are incorporated and included in § 63.14. § 63.15 Availability of Information/Confidentiality Yes § 63.16(a) Performance Track Provisions—reduced reporting Yes § 63.16(b)-(c) Performance Track Provisions—reduced reporting No Subpart HHHHHH does not establish numerical emission limits. [FR Doc. E7-24718 Filed 1-8-08; 8:45 am] BILLING CODE 6560-50-P 73 6 Wednesday, January 9, 2008 Rules and Regulations Part IV Department of Energy Federal Energy Regulatory Commission 18 CFR Part 40 Facilities Design, Connections and Maintenance Reliability Standards; Final Rule DEPARTMENT OF ENERGY Federal Energy Regulatory Commission 18 CFR Part 40 [Docket No. RM07-3-000; Order No. 705] Facilities Design, Connections and Maintenance Reliability Standards Issued December 27, 2007. AGENCY: Federal Energy Regulatory Commission, DOE. ACTION: Final rule. SUMMARY: Pursuant to section 215 of the Federal Power Act, the Commission approves three Reliability Standards concerning Facilities Design, Connections and Maintenance that were developed by the North American Electric Reliability Corporation (NERC), the Commission-certified Electric Reliability Organization
(ERO)responsible for developing and enforcing mandatory Reliability Standards. Further, pursuant to section 215(d)(5), we direct the ERO to develop a modification to one of the three Reliability Standards that are being approved as mandatory and enforceable. The three FAC Reliability Standards, designated FAC-010-1, FAC-011-1 and FAC-014-1, require planning authorities and reliability coordinators to establish methodologies to determine system operating limits for the Bulk-Power System in the planning and operation horizons. The Commission also approves a regional difference for the Western Interconnection administered by the Western Electricity Coordinating Council which is incorporated into FAC-010-1 and FAC-011-1. In addition, the Commission accepts three new terms for the NERC Glossary of Terms Used in Reliability Standards, remands another proposed term, and directs the ERO to submit modifications to its proposed Violation Risk Factors consistent with our prior orders. DATES: *Effective Date:* The approval granted in this order becomes effective due February 8, 2008. FOR FURTHER INFORMATION CONTACT: Christy Walsh (Legal Information), Office of the General Counsel, Federal Energy Regulatory Commission, 888 First Street, NE., Washington, DC 20426,
(202)502-6523. Robert Snow (Technical Information), Office of Electric Reliability, Division of Reliability Standards, Federal Energy Regulatory Commission, 888 First Street, NE., Washington, DC 20426,
(202)502-6716. SUPPLEMENTARY INFORMATION: *Before Commissioners:* Joseph T. Kelliher, Chairman; Suedeen G. Kelly, Marc Spitzer, Philip D. Moeller, and Jon Wellinghoff. Paragraph Number I. Introduction 1 II. Background 2 A. EPAct 2005 and Mandatory Reliability Standards 2 B. NERC's Proposed FAC Reliability Standards 4 C. Notice of Proposed Rulemaking 10 III. Discussion 13 A. General Matters 15 B. Specific Issues 18 1. Consistency With Order No. 890 18 2. Loss of Consequential Load 50 3. Loss of Shunt Device 54 4. Load Forecast Error Under FAC-011-1 59 5. Other Issues 72 6. Effective Date 80 C. Western Interconnection Regional Difference 85 D. New Glossary Terms 97 1. Cascading Outages 98 2. IROL 118 3. IROL Tv 125 E. Violation Risk Factors 129 1. General Issues 132 2. Requirements R2 and R2.1—R2.2.3 for FAC-010-1 and FAC-011-1 147 3. FAC-014-1, Requirement R5 167 4. FAC-010-1, Requirement 3.6 178 5. FAC-011-1, Requirement 3.4 179 IV. Information Collection Statement 180 V. Environmental Analysis 185 VI. Regulatory Flexibility Act Certification 186 VII. Document Availability 189 VIII. Effective Date and Congressional Notification 192 I. Introduction 1. Pursuant to section 215 of the Federal Power Act (FPA), the Commission approves three Reliability Standards concerning Facilities Design, Connections and Maintenance
(FAC)that were developed by the North American Electric Reliability Corporation (NERC), the Commission-certified Electric Reliability Organization
(ERO)responsible for developing and enforcing mandatory Reliability Standards. Further, pursuant to section 215(d)(5), we direct the ERO to develop a modification to one of the three Reliability Standards that are being approved as mandatory and enforceable. The three FAC Reliability Standards, designated FAC-010-1, FAC-011-1 and FAC-014-1, require planning authorities and reliability coordinators to establish methodologies to determine system operating limits
(SOLs)for the Bulk-Power System in the planning and operation horizons. The Commission also approves a regional difference for the Western Interconnection administered by the Western Electricity Coordinating Council
(WECC)which is incorporated into FAC-010-1 and FAC-011-1. In addition, the Commission accepts three new terms for the NERC Glossary of Terms Used in Reliability Standards, remands another proposed term, and directs the ERO to submit modifications to its proposed Violation Risk Factors consistent with our prior orders. II. Background A. EPAct 2005 and Mandatory Reliability Standards 2. On August 8, 2005, the Electricity Modernization Act of 2005, which is Title XII, Subtitle A, of the Energy Policy Act of 2005 (EPAct 2005), was enacted. 1 EPAct 2005 adds a new section 215 to the FPA, which requires a Commission-certified ERO to develop mandatory and enforceable Reliability Standards that are subject to Commission review and approval. Once approved, the Reliability Standards may be enforced by the ERO, subject to Commission oversight, or the Commission can independently enforce Reliability Standards. 2 1 Energy Policy Act of 2005, Pub. L. No 109-58, Title XII, Subtitle A, section 1211(a), 119 Stat. 594, 941 (2005), 16 U.S.C. 824o (2000 & Supp. V 2005). 2 FPA section 215(e), 16 U.S.C. 824o(e) (2000 & Supp. V 2005). 3. On February 3, 2006, the Commission issued Order No. 672, implementing section 215 of the FPA. 3 Pursuant to Order No. 672, the Commission certified one organization, NERC, as the ERO. 4 The ERO is required to develop Reliability Standards, which are subject to Commission review and approval. Approved Reliability Standards apply to users, owners and operators of the Bulk-Power System, as set forth in each Reliability Standard. 3 *Rules Concerning Certification of the Electric Reliability Organization; and Procedures for the Establishment, Approval and Enforcement of Electric Reliability Standards,* Order No. 672, 71 FR 8662 (Feb. 17, 2006), FERC Stats. & Regs. ¶ 31,204 (2006), *order on reh'g* , Order No. 672-A, 71 FR 19814 (Apr. 18, 2006), FERC Stats. & Regs. ¶ 31,212 (2006). 4 *North American Electric Reliability Corp.,* 116 FERC ¶ 61,062 (ERO Certification Order), *order on reh'g & compliance,* 117 FERC ¶ 61,126
(2006)(ERO Rehearing Order). B. NERC's Proposed FAC Reliability Standards 4. On November 15, 2006, NERC filed 20 revised Reliability Standards and three new Reliability Standards for Commission approval. The Commission addressed the 20 revised Reliability Standards in Order No. 693 5 and established this rulemaking proceeding to review the three new Reliability Standards. 5 On March 16, 2007, the Commission approved 83 of the 107 Reliability Standards initially filed by NERC. *See Mandatory Reliability Standards for the Bulk-Power System,* Order No. 693, 72 FR 16416 (Apr. 4, 2007), FERC Stats. and Regs. ¶ 31,242, *order on reh'g,* Order No. 693-A, 120 FERC ¶ 61,053 (2007). 5. NERC states that the three new Reliability Standards ensure that SOLs and interconnection reliability operating limits (IROLs) 6 are developed using consistent methods and that those methods contain certain essential elements. NERC designated the new Reliability Standards as follows: 6 As discussed later, NERC has proposed the following definition of IROL, “a System Operating Limit that, if violated, could lead to instability, uncontrolled separation, or Cascading Outages that adversely impact the reliability of the Bulk Electric System.” FAC-010-1 (System Operating Limits Methodology for the Planning Horizon); FAC-011-1 (System Operating Limits Methodology for the Operations Horizon); and FAC-014-1 (Establish and Communicate System Operating Limits). 6. NERC explains that FAC-010-1 requires each planning authority to document its methodology for determining SOLs and share its methodology with reliability entities. FAC-010-1 provides that the planning authority shall have a documented SOL methodology within its planning area that is applicable to the planning time horizon, does not exceed facility ratings, and includes a description of how to identify the subset of SOLs that qualify as IROLs. Requirement R2 of the Reliability Standard and its subparts identify specific considerations that must be included in the methodology. 7. Reliability Standard FAC-011-1 requires each reliability coordinator to develop a SOL methodology for the operations time frame. This methodology must determine whether certain stability limits that are derived from multiple contingency analysis and provided by the planning authority are applicable in the operating horizon. Requirement R2 of FAC-011-1 identifies specific considerations that must be included in the methodology in both a pre-contingency state and following one or multiple contingencies. The provisions of Requirement R2 of FAC-011-1 are the same as those in Requirement R2 of FAC-010-1, except for Requirement R2.3.2 of FAC-011-1, discussed below, which addresses load shedding when studies underestimate real time conditions. 8. Both FAC-010-1 and FAC-011-1 include an Interconnection-wide regional difference for the Western Interconnection administered by WECC. These regional differences incorporate a more detailed methodology to determine SOLs based on specified multiple contingencies. They also provide that the “Western Interconnection may make changes” to the contingencies required to be studied and/or the required responses to contingencies for specific facilities. 9. Reliability Standard FAC-014-1 requires each reliability coordinator, planning authority, transmission planner, and transmission operator to develop and communicate SOL limits in accordance with the methodologies developed pursuant to FAC-010-1 and FAC-011-1. FAC-014-1 requires the reliability coordinator to ensure that SOLs are established for its “reliability coordinator area” and that the SOLs are consistent with its SOL methodology. It provides that each transmission operator, planning authority, and transmission planner must establish SOLs as directed by its reliability coordinator that are consistent with the reliability coordinator's methodology. Further, FAC-014-1 requires the reliability coordinator, planning authority, and transmission planner to provide its SOLs to those entities that have a reliability-related need. 7 7 The Notice of Proposed Rulemaking
(NOPR)provides additional background on the content of each FAC Reliability Standard. *Facilities, Design, Connections and Maintenance Mandatory Reliability Standards,* Notice of Proposed Rulemaking, 72 FR 160 (Aug. 20, 2007), FERC Stats. And Regs. ¶ 32,622, at P 9-36 (Aug. 13, 2007). C. Notice of Proposed Rulemaking 10. On August 13, 2007, the Commission issued a NOPR proposing to approve Reliability Standards FAC-010-1, FAC-011-1, and FAC-014-1 as mandatory and enforceable Reliability Standards. The Commission also proposed to approve regional differences to FAC-010-1 and FAC-011-1 applicable to the Western Interconnection. In addition, the Commission sought ERO clarification and public comment on whether the FAC Reliability Standards are consistent with the Commission's transmission reform efforts in Order No. 890 8 and with the transmission planning
(TPL)Reliability Standards. The NOPR also sought ERO clarification and public comment on the scope of operating contingencies and appropriate responses under the Reliability Standard requirements, on the Commission's proposal to approve the WECC regional difference, and on the WECC contingency designation and revision process should be incorporated into the Reliability Standard. Further, the Commission proposed certain clarifications to NERC's glossary revisions. 8 *Preventing Undue Discrimination and Preference in Transmission Service,* Order No. 890, 72 FR 12266 (Mar. 15, 2007), FERC Stats. & Regs. ¶ 31,241 (2007). 11. After submitting these FAC Reliability Standards, NERC filed proposed Violation Risk Factors that correspond to each Requirement of the proposed Reliability Standards. 9 According to NERC, Violation Risk Factors measure the relative risk to the Bulk-Power System associated with the violation of Requirements within the Reliability Standards. 9 *See* NERC, Request for Approval of Violation Risk Factors for Version 1 Reliability Standards, Docket No. RR07-10-000, Exh. A (March 23, 2007); and NERC, Request for Approval of Supplemental Violation Risk Factors for Version 1 Reliability Standards, Docket No. RR07-12-000, Exh. A (May 4, 2007). In its orders addressing the violation risk factors, the Commission addressed only those Violation Risk Factors pertaining to the 83 Reliability Standards approved in Order No. 693. *North American Electric Reliability Corp.,* 119 FERC ¶ 61,145, at P 14
(2007)( *Violation Risk Factor Order* ) and *North American Electric Reliability Corp.* , 119 FERC ¶ 61,321, at P 4
(2007)( *Supplemental VRF Order* ). Procedural Matters 12. The Commission required that comments be filed within 30 days after publication in the **Federal Register** , or September 19, 2007. Approximately 21 entities filed comments, including several late-filed comments. The Commission accepts these late filed comments. Appendix B provides a list of the commenters. III. Discussion 13. This order approves the FAC Reliability Standards, as discussed below. 10 In approving the FAC Reliability Standards, the Commission concludes that they are just, reasonable, not unduly discriminatory or preferential, and in the public interest. These three Reliability Standards serve an important reliability purpose in ensuring that SOLs used in the reliable planning and operation of the Bulk-Power System are determined based on an established methodology. Moreover, they clearly identify the entities to which they apply and contain clear and enforceable requirements. The Commission also accepts the WECC regional differences contained in FAC-010-1 and FAC-011-1. The Commission will discuss particular issues below as appropriate. 11 10 The three Reliability Standards will not be published in revised Commission regulations, but instead are available in Appendix C through the Commission's eLibrary document retrieval system in Docket No. RM07-3-000 and will be posted on NERC's *Web site, https://standards.nerc.net/.* 11 In addition to the issues discussed, the NOPR requested that NERC clarify its proposals to replace the term “regional reliability organization” with the term Regional Entity and to incorporate references to the “planning coordinator” function into the Reliability Standards. We are satisfied with the explanations provided by NERC. 14. The Commission also directs NERC to modify FAC-011-1, Requirement 2.3. In addition, we accept NERC's proposals to add or revise the following terms in the NERC glossary: “Delayed Fault Clearing,” “Interconnection Reliability Operating Limit (IROL),” and “Interconnection Reliability Operating Limit T v (IROL T v ).” 12 However, for the reasons explained below, we remand NERC's definition of “Cascading Outages” subject to NERC refiling. Finally, with respect to the Violation Risk Factors, we accept certain Violation Risk Factors but direct NERC to revise the Violation Risk Factors that are inconsistent with the Commission's Violation Risk Factor guidelines, as discussed below. 12 In Order No. 693 at P 1893-98, the Commission approved the NERC glossary, directing specific modifications to the document. A. General Matters 15. Several commenters sought clarification of the Commission's procedural approach, arguing that changes to Reliability Standards and glossary terms should be made through the NERC Reliability Standards development process. 13 Some commenters question the Commission's authority to require NERC to make specific revisions to the Reliability Standards and glossary terms. 14 13 *See* Progress Energy Comments at 2 (citing Order No. 672 at P 40, 249 and 344); *see also* EEI and APPA, and NRECA Comments. 14 *See, e.g.* , NRECA Comments. Commission Determination 16. In response to commenters' concerns about the Commission's procedural approach, section 215(d) of the FPA provides that the Commission shall give due weight to the technical expertise of the ERO with respect to the content of a proposed Reliability Standard or modification to a Reliability Standard; and the Commission fully intends to faithfully implement this provision. Further, the Commission affirms the approach set forth in Order No. 693 that: [A] direction for modification should not be so overly prescriptive as to preclude consideration of viable alternatives in the ERO's Reliability Standards development process. However, in identifying a specific matter to be addressed in a modification to a Reliability Standard, it is important that the Commission provide sufficient guidance so that the ERO has an understanding of the Commission's concerns and an appropriate but not necessarily, exclusive, outcome to address those concerns.[ 15 ] 15 Order No. 693 at P 185. 17. Thus, in directing modification to FAC-011-1, while we provide specific details regarding the Commission's expectations, we intend by doing so to provide useful guidance to assist in the Reliability Standards development process, not to impede it. 16 As stated in Order No. 693, this is consistent with statutory language that authorizes the Commission to order the ERO to submit a modification “that addresses a specific matter” if the Commission considers it appropriate to carry out section 215 of the FPA. 17 Consistent with Order No. 693, while the Commission offers a specific approach to address our concern with FAC-011-1, we will consider an equivalent alternative approach provided that the ERO demonstrates that the alternative will address the Commission's underlying concern or goal as efficiently and effectively as the Commission's proposal. 18 16 Order No. 693 at P 186. 17 FPA section 215(d)(5), 16 U.S.C. 824o(d)(5) (2000 & Supp. V 2005). 18 Order No. 693 at P 186. B. Specific Issues 1. Consistency With Order No. 890 18. The NOPR stated the Commission's concern that the FAC Reliability Standards called for the development of distinct methodologies to calculate system transfer limits and that these methodologies might differ from those used in the planning and operations horizons to develop available transfer capability
(ATC)and total transfer capability
(TTC)transfer limits. The NOPR explained that Order No. 890 amended the *pro forma* open access transmission tariff
(OATT)to provide greater specificity to reduce opportunities for undue discrimination and increase transparency in the rules applicable to planning and use of the transmission system. 19 Specifically, Order No. 890 requires the consistent use of assumptions underlying operational planning for short-term ATC calculations and expansion planning for long-term ATC calculations. 20 19 NOPR at P 18-19 (citing Order No. 890 at P 290-95). 20 Order No. 890 at P 290-95. 19. The NOPR noted that FAC-010-1 requires each planning authority to document its methods for determining system operating limits or SOLs for the planning horizon. However, the SOLs may affect ATC by determining transmission path or system interface limits. Furthermore, the NOPR noted that use of multiple contingency analyses would generally result in lower SOLs. The Commission expressed concern about potentially disparate results for calculating transfer limits under two methodologies, the first being the proposed Reliability Standard FAC-010-1 methodology for calculation of SOLs for the planning horizon and another being the methodology for calculating long-term ATC pursuant to NERC's Modeling, Data, and Analysis
(MOD)Reliability Standards. Therefore, the NOPR requested comment whether having separate methodologies was consistent with the Order No. 890 requirement to use consistent assumptions. 20. The Commission had previously found that calculations of TTC transfer limits calculated under other FAC Reliability Standards, specifically FAC-012-1, were essentially the same as transfer limits calculated for modeling purposes under the MOD Reliability Standard, MOD-001-1, and therefore required the calculations to be addressed under a single Reliability Standard. The NOPR set out two specific concerns, the first being whether there is a potential for undue discrimination as a result of the use of single and multiple contingencies in different contexts. The second concern was whether the use of different approaches to transfer limit calculations under FAC-010-1, under review in this proceeding on the one hand, and FAC-012-1, which was previously approved in Order No. 693, was consistent with the Commission's prior determination that NERC should not establish multiple Reliability Standards for the same purpose. 21. The NOPR raised similar issues for Reliability Standard FAC-011-1. Specifically, the Commission was concerned with the potential exercise of undue discrimination given the possibility for differing results with the use of single and multiple contingency analyses for SOLs in the operating horizon under FAC-011-1 and short-term ATC calculations, and second whether consistency was better reflected through coordinated and consistent criteria for the calculation of operating horizon SOLs and short-term ATC. We will address these issues in the context of FAC-010-1 and FAC-011 together, given the common issue to both Reliability Standards. Most commenters address the concerns together as well. Comments on Undue Discrimination 22. NERC, as well as the majority of industry representatives, takes the position that there is no potential for undue discrimination with the addition of the FAC SOL methodologies, 21 in particular if consistency is provided for among the FAC, planning and operations methodologies. 22 The NERC comments state that its draft ATC Reliability Standard requirements provide for consistency with the FAC-010-1 and FAC-011-1 assumptions and conditions. The NERC comments describe this coordination: 21 *See, e.g.,* NERC and EEI and APPA Comments. 22 *See, e.g.,* MidAmerican, NYSRC and NYISO, PG&E, Progress Energy, Southern and WECC Comments. EPSA argues that ATC assumptions cannot be more stringent than planning assumptions to ensure that capacity is adequate. Draft reliability standard MOD-028-1—Area Interchange Methodology requires the transmission operator to document that its model uses the same facility ratings as provided by the transmission owner. It also requires that the assumptions and contingencies used in determining TTC be consistent with those used for the same time horizon in operations and planning studies. Draft MOD-029-1—Rated System Path Methodology requires the transmission operator to document that its model uses the same facility ratings as provided by the transmission owner. It also requires that the assumptions and contingencies used in determining TTC be consistent with those used for the same time horizon in operations and planning studies. Draft MOD-030-1—Flowgate Methodology requires the transmission operator to document that its model uses the same facility ratings as provided by the transmission owner. It also requires that the assumptions and contingencies used in determining flowgates to match the contingencies and assumptions used in operations studies and planning studies for the applicable time periods. The links between the FAC standards and the MOD standards outlined above support the Commission's directives in Order 890 regarding the transparency requirements and mitigate potential for the exercise of undue discrimination. 23 23 NERC Comments at 18-20. 23. According to NERC, this ensures that the contingencies and assumptions used in the planning horizon under FAC-010-1 and the contingencies and assumptions used in the operating horizon under FAC-011-1 are consistent with the contingencies and assumptions used in calculating TTC and ATC for various time horizons. 24. Supplier and customer groups argue that there is a potential for undue discrimination if system operation and planning are not executed in a manner that is consistent with short- and long-term TTC assumptions. 24 Some commenters assert that there is no potential for discrimination in independently operated independent system operator
(ISO)and regional transmission organization
(RTO)systems. 25 The commenters largely agree that the potential for undue discrimination is mitigated insofar as the Order No. 890 transparency requirements promote open and consistent ATC calculations, because transparency allows any party to review and challenge the SOL criteria and methodology. 26 24 *See* EPSA and NRECA Comments. 25 *See* NYISO and Ontario IESO, ISO/RTO Council, and NYSRC and NYISO Comments. 26 *See, e.g.,* Duke and EPSA Comments; *but see* NRECA Comments (arguing that differences between operating and planning assumptions make new users vulnerable to confusion). 25. NERC and others emphasize the consistency and coordination already required between the contingencies and assumptions used to determine SOLs for the planning horizon under the SOL methodology specified in FAC-010-1, on the one hand, and the contingencies and assumptions to develop TTCs which determine ATC. NERC states that FAC-010-1 requires planning authorities to have an explicit methodology to develop SOLs and must make this methodology available to all parties having a reliability-related need for the methodology or the limits so determined. This openness mitigates or prevents the exercise of undue discrimination. 27 27 BPA, PG&E and WECC agree that disclosure mitigates the potential for undue discrimination. Ameren argues that the list provided for in FAC-014-1, Requirement R6 should be supplied to the relevant transmission provider and transmission operator, in addition to the Planning Authority. 26. Furthermore, NERC states that the FAC Reliability Standards are coordinated with the development of pending MOD Reliability Standards, and this coordination supports transparency and mitigates the potential for the exercise of undue discrimination, consistent with Order No. 890. NERC notes that Order No. 693 did not approve Reliability Standard MOD-001-0 but directed specific improvements. Consequently, NERC is revising that Reliability Standard and preparing the three draft Reliability Standards described above. These draft Reliability Standards will set forth three currently used TTC and ATC calculation methodologies. 28 Although each of these three methodologies provides a different approach to the calculation of TTC, all require consistency between the contingencies and assumptions used in the determination of TTC and the contingencies and assumptions used in operating and planning studies for concurrent time periods. 28 *See* NERC Comments at 9-10 for a description of the methodologies. 27. EEI and APPA are concerned that the Commission may be duplicating efforts underway pursuant to Order Nos. 890 and 693, which addressed competitive and reliability policy issues associated with the development and posting of ATC and TTC. EEI and APPA note that public utility transmission providers have recently posted for public review and comment the proposed Attachment Ks to their OATTs, proposing transmission planning and expansion methodologies, while a NERC Reliability Standards drafting team is developing a Reliability Standard covering the calculation of all elements of transfer capability, including ATC and TTC. According to EEI and APPA, the work of the NERC ATC Reliability Standard drafting team builds on the Reliability Standard proposed for Commission approval in this proceeding. EEI and APPA recommend that the Commission allow the industry to complete the intensive work required for implementation of Order Nos. 890 and 693 without the uncertainty that the Commission may seek to modify the scope and direction already established through material changes to the Reliability Standards proposed for approval in this proceeding. 28. The ISO/RTO Council comments that there may be the potential for undue discrimination, but not in grids operated by ISOs due to the lack of economic incentives. Furthermore, because ISOs and RTOs operate centralized dispatch markets, they do not rely on physical path reservations within their boundaries. Therefore, these commenters conclude that ATC calculation is not critical. 29 29 NYSRC, NYISO and Ontario IESO take similar positions. The Commission notes that the cited analyses would not apply for transactions that cross ISO and RTO boundaries. 29. Other commenters claim that coordination should not be so stringent to interfere with the different uses for the different transfer limit methodologies. MidAmerican maintains that the concurrent use of single and multiple contingencies is appropriate so long as appropriate coordination is made for long- and short-term analyses and ATC and operations planning. MidAmerican asserts that SOLs and TTC should remain distinct to allow the optimum reservation and use of the transmission system, while permitting appropriate responses to outages in the operations horizon. MidAmerican states that SOLs must change to incorporate current system operating information, addressing the “next contingency” to remain in a secure state, and that requiring SOLs to equal TTCs may result in less transmission capacity available for sale or increased reliance on transmission loading relief. The resulting lack of capacity may prevent transmission providers from meeting existing transmission contract obligations. 30. Santa Clara states that there is a need for consistency in the SOL methodology used by the reliability coordinator and the planning authority. Also, Santa Clara claims that conflicts could result for engineering design and/or operational criteria if a planning authority's SOL methodology calls for single contingency analysis, but a reliability coordinator or planning authority calculates long-term ATC using multiple contingencies. Therefore, Santa Clara concludes that FAC-010-1 and FAC-011-1 should be consistent in the SOL methodologies used by planning authorities and reliability coordinators. 31. Commenters disagree as to the impact of performing SOL determinations based on single contingencies while ATC is calculated using multiple contingencies. Several commenters argue that when SOLs are determined using single contingencies and ATC is calculated using multiple contingencies, the lack of consistency could permit discrimination in ATC calculation for transmission service. 30 EPSA argues that this potential must be addressed to fulfill the Order No. 890 requirement that transmission providers use short- and long-term ATC data and modeling assumptions that are consistent with operations and system expansion assumptions. Also, EPSA states that under Order No. 890 the Commission must ensure that planning and service capacity calculations are consistent and non-discriminatory. EPSA argues that FAC Reliability Standards that affect transmission planning cannot be divorced from the calculation of ATC and that use of different assumptions for planning and ATC could lead to inadequate capacity. 30 *See, e.g.* , EPSA and NYISO and NYSRC Comments. NRECA agrees that there is a potential for undue discrimination when there are differences in the treatment of single and multiple contingencies in the near and long term. 32. Ameren states that Reliability Standards should not impose inconsistent obligations on system users, but notes some calculations that appear similar may be different due to different applications. For instance, SOL system limit calculations may differ from planning calculations due to their application to different timeframes. Ameren argues that FAC-010 should be consistent with the transmission planning Reliability Standard TPL-002-0 for the long-term planning horizon, but acknowledges that FAC-010 may not be consistent with TPL-002-0 for the near-term planning horizon, to accommodate overload or low voltage mitigation efforts. Ameren requests that, to prevent the imposition of conflicting obligations, the Commission not accept the Reliability Standards and direct NERC to monitor the interrelated Reliability Standards for consistency. 33. NRECA maintains that different methodologies may discriminate in particular against new entrants who are unfamiliar with the differences. NRECA states that there are some circumstances in which a transmission provider may be able to benefit because it will have preferential access to transmission expansion information, especially where the planning authority and reliability coordinator reside in the same corporate family. 34. Several commenters request that the Commission delay approval and direct the ERO to evaluate the issues. 31 Progress Energy asserts that, to ensure consistency, the planning authority and reliability coordinator should use the same number of contingencies and the same categories of facility ratings to determine these values for its transmission system. EPSA argues that ATC assumptions cannot be more stringent than planning assumptions and that SOL contingencies must “be in balance” with ATC contingencies. 31 *See, e.g.* , NYSRC and NYISO, and NRECA Comments. Comments on Consistency for SOLs, Transfer Capability and TTC 35. The second concern set out in the NOPR concerned whether the existence of different approaches to transfer limit calculations under FAC-010-1 and FAC-011, on the one hand, and FAC-012-1, on the other, was consistent with the Commission's prior determination that calculations of TTC transfer limits calculated under the FAC Reliability Standards were essentially the same as transfer limits calculated for Modeling purposes under the MOD Reliability Standard, MOD-001-1. Foreseeing a similar connection between facility transfer limit calculations under FAC-010-1 and ATC transfer limit calculations, the NOPR requested comment whether the FAC Reliability Standards should reflect any such consistency. 36. NERC states that the TPL Reliability Standards set the foundation for the types of contingencies to be considered for the Requirements in the FAC Reliability Standards. The FAC Reliability Standards are intended to be consistent with the set of contingencies identified in the TPL Reliability Standards. The FAC Reliability Standards define facility ratings and system operating limits that are used as the basis for limits that are used in the determination of the ATC values within MOD Reliability Standards. As the TPL series of Reliability Standards are modified, conforming changes to the FAC and/or MOD series of Reliability Standards are expected to be necessary to ensure consistency in the list of contingencies. 37. In response to the Commission's statement that SOLs will change as additional contingencies are considered, EEI and APPA provide a description of how IROLs and SOLs are determined. When IROL and SOL values are determined, they are based on a worst-contingency criterion as defined by applicable planning or operating criteria for a given set of Bulk-Power System conditions. Therefore, according to EEI and APPA, unless the underlying set of system conditions change, it would be extremely unusual for IROL and SOL values to change. 32 32 *Cf* . MidAmerican Comments at 7 (stating that SOLs change to account for actual or planned outages); and Southern Comments at 4-5 (noting that historically, power flow analyses were used to develop SOLs in the absence of real-time data, but that it is now possible to perform real-time contingency analysis and identify SOLs based on actual system conditions and facility loads). 38. EEI and APPA state that SOLs are calculated and used to represent thermal, voltage, and stability limits for planning and operation of the Bulk-Power System with distinct calculation methods for SOLs under the three types of limits. For instance, a thermal-limit SOL is determined through a contingency analysis that models a facility as out of service while ensuring that the resulting flow is below the thermal ratings for each remaining facility. A voltage or stability limit SOL is determined by monitoring the flows on a facility or group of facilities to ensure voltage or stability criteria are not exceeded. These types of SOLs are commonly defined by planning authorities in their periodic studies, based on the pertinent Reliability Standards and other planning or operations criteria. 39. Other commenters generally agree that SOLs and TTCs are not the same. 33 Several commenters describe SOLs as one of many inputs used to develop TTC and, consequently, ATC. 34 Commenters distinguish SOLs and TTC/ATC, noting that TTC and ATC are defined by path (i.e., between a receipt point and delivery point) whereas an SOL applies to the discrete facilities that comprise the interconnected generation and transmission system (such as conductors, breakers and transformers). Also, SOLs vary based on season because of changes in ambient temperature, anticipated weather, and other variations in operational conditions. 35 In contrast, TTC and ATC are recalculated dependent on other circumstances including system usage and contractual reservations. These and other differences prompt the commenters to state that the processes for determining SOLs and TTC/ATC are necessarily different. 33 *See, e.g.* , NERC, Progress Energy, WECC, Southern, Duke, PG&E and SoCal Edison Comments. 34 *See, e.g.* , NERC, Progress Energy, Duke, PG&E and SoCal Edison Comments. 35 *See, e.g.* , NERC and Progress Energy Comments; *see also* WECC Comments. Although comments vary as to whether SOLs are permanently set or may be updated based on new information, this apparent disagreement appears to stem from use of different terms. Thus, while individual facility ratings are unlikely to change, the particular facility that is establishing the system limits in the N-1 contingency analysis will vary as conditions change and adjustments are made. 40. Several commenters note that SOL, ATC and TTC perform different functions. 36 These commenters concur that while assumptions should generally be consistent, complete consistency is neither achievable nor desirable. Duke states that while both SOLs and TTC may be based on fixed dispatch and interchange, FAC-010-1, or varying dispatch and interchange, FAC-011-1, they should still be evaluated against the same N-1 contingencies in a coordinated and consistent manner. 36 *See* ISO/RTO Council and Southern Comments. 41. Most commenters argue in favor of coordination of SOL and TTC assumptions and conditions but disagree on the degree to which such consistency requires additional explicit guidance in the Reliability Standards. NERC maintains that the proposed FAC Reliability Standards and the MOD Reliability Standards under development already require consistency between one another with respect to assumptions and contingencies and additional coordination is not needed to support the Commission's directives in Order No. 890. SoCal Edison concurs that actual coordination is not necessary, but suggests that the ATC-related Reliability Standards reference the FAC Reliability Standards to provide clarity. 42. Southern requests, in response to FAC-011-1, that the Commission clarify that a policy of consistency between short-term ATC calculations and operations planning, on the one hand, and long-term ATC calculations and system expansion planning on the other does not support a finding that data and modeling assumptions for short-term assessments should be consistent with assumptions for long-term assessments. While assumptions are generally consistent, complete consistency is neither achievable nor desirable. 43. EPSA states that the Commission must ensure that planning and service capacity are calculated on a consistent, non-discriminatory basis, and argues that planning based on single contingencies combined with multiple contingency ATC calculations could lead to an inefficient transmission system, where service reservations cannot be met in real time. 44. NYSRC and NYISO argue that multiple contingency analyses in the operating horizon under FAC-011-1, such as that employed by WECC, should be applied in all of North America. NYSRC and NYISO note that their Regional Entity, Northeast Power Coordinating Council (NPCC), has included a multiple element requirement in its operating criteria for 40 years without problems. They conclude that multiple element contingencies are not uncommon and the system's ability to survive such incidents should be supported by appropriate operating Reliability Standards, not left to chance. 45. NYSRC and NYISO states that the FAC-011-1 drafting team maintains that lower operating limits due to multiple element requirements would restrict competition. However, NYSRC and NYISO argue that this suggests that the mere possibility that a Reliability Standard may restrict competitive transactions is not a sufficient reason for not adopting the Reliability Standard, even if it would be effective in maintaining system reliability. They contend that permitting competitive concerns to outweigh reliability would be inconsistent with the Commission's responsibility to ensure reliability. Commission Determination 46. The Commission will not direct NERC to revise the FAC Reliability Standards to address Order No. 890 consistency issues. Given that the SOLs developed pursuant to the FAC Reliability Standards will be inputs to the calculation of TTC and ATC under the MOD Reliability Standards currently under development, the Commission agrees with commenters that SOLs are not the same as TTC used for ATC calculation. However, we note that SOLs are a significant component in TTC calculation. 47. Further, the Commission is persuaded by NERC's comments that it will coordinate the assumptions and conditions considered in system planning under the TPL Reliability Standards, SOL determination under the FAC Reliability Standards and TTC calculation under the MOD Reliability Standards. 48. At this time, the Commission disagrees with the commenters that argue that there is a potential for undue discrimination in the FAC Reliability Standards. The Commission raised the question regarding the application of the SOL methodology in the FAC Reliability Standards compared with the calculation of ATC. However, NERC has not at this time filed the Reliability Standards concerning TTC and ATC calculation. The Commission notes that it has previously provided directives concerning the need for coordination and consistency among short- and long-term ATC calculations, operations planning and system expansion determinations. The Commission agrees with commenters that the directives concerning consistency in Order Nos. 693 and 890 should alleviate concerns about the potential for undue discrimination. These directives are currently being addressed by NERC in Reliability Standards under development. We will not change those directives in this proceeding. When NERC files revised MOD Reliability Standards for calculating ATC or TTC, the Commission will review the resulting Reliability Standards for compliance with our directives in Order Nos. 890 and 693 concerning consistency for SOLs, transfer capability and TTC. 37 37 Our determination here not to revise prior directives also addresses Southern's request, in response to FAC-011-1, that the Commission clarify its policy of consistency between operations planning and system expansion planning relative to TTC calculations. 49. Because the TPL series of Reliability Standards sets the foundation for the types of contingencies to be considered to meet requirements in the FAC Reliability Standards, and the FAC Reliability Standards are intended to be consistent with the set of contingencies identified in the TPL Reliability Standards, the Commission would be concerned if the TPL Reliability Standards use one set of contingencies to plan the system, while the FAC Reliability Standards generate another set to calculate SOLs in the planning horizon. As NERC acknowledges, as the TPL series of Reliability Standards is modified, conforming changes to the corresponding lists of contingencies in the FAC or MOD series of Reliability Standards are expected to be necessary to ensure consistency in the list of contingencies. Similarly, the Commission believes that as FAC or MOD Reliability Standards are updated, the TPL series of Reliability Standards must be updated to remain consistent. Therefore, we direct that any revised TPL Reliability Standards must reflect consistency in the lists of contingencies between the two Reliability Standards. 38 Should NERC file such revised TPL Reliability Standards, the Commission will review the resulting Reliability Standards for compliance with our directives in Order Nos. 890 and 693 concerning consistency for SOLs, transfer capability and TTC. 38 Similar consistency issues may arise with the transmission operating and planning
(TOP)Reliability Standards because those Reliability Standards implement the SOLs and IROLs determined in the FAC Reliability Standards. 2. Loss of Consequential Load 50. The NOPR requested that NERC, as the ERO, clarify the discussion of network customer interruption in FAC-010-1, Requirement R2.3. Requirement R2.3 provides that the system's response to a single contingency may include, *inter alia,* “planned or controlled interruption of electric supply to radial customers or some local network customers connected to or supplied by the Faulted Facility or by the affected area.” 39 The NOPR asked whether this provision is limited to the loss of load that is a direct result of the contingency, i.e., consequential load, or whether this provision allows firm load shedding and firm transmission curtailment following a single contingency. 40 39 Identical language appears in FAC-011-1, Requirement R2.3. Our analysis applies to that provision as well. 40 Order No. 693 defined consequential load, at P 1794 n.461: “Consequential load is the load that is directly served by the elements that are removed from service as a result of the contingency.” Comments 51. NERC clarifies that the provision in FAC-010-1, Requirement R2.3 is limited to loss of load that is a direct result of the contingency, i.e., consequential load loss. Several commenters concur with that interpretation. 41 NYSRC and NYISO state that in NPCC, firm-load shedding is only allowed following a recognized contingency if reliability cannot be assured for a subsequent contingency through normal control actions (citing dispatch and use of direct current sources). 41 *See, e.g.* , NYSRC, NYISO, Ontario IESO, SoCal Edison and Southern Comments. 52. Ameren states that for the long term planning horizon, no load is dropped except for load served directly by an out-of-service facility. However, in the operational or near term planning horizon, operating guidelines may call for dropping load to mitigate overload or low-voltage conditions until the necessary system reinforcements or restorations are completed. Therefore, Ameren thinks a distinction is appropriate. Commission Determination 53. In response to the NYSRC and NYISO comments, the Commission reiterates its holding that addressed similar language on loss of load in Order No. 693, regarding Reliability Standard TPL-002-0. In Order No. 693, the Commission noted that “allowing for the 30 minute system adjustment period, the system must be capable of withstanding an N-1 contingency, with load shedding available to system operators as a measure of last resort to prevent cascading failures.” 42 Order No. 693 stated that the transmission system should not be planned to permit load shedding for a single contingency. 43 Order No. 693 directed NERC to clarify the planning Reliability Standard TPL-002-0 accordingly. The Commission reaches the same conclusion here. We will approve Reliability Standard FAC-010-1, Requirement R2.3 and the ERO should ensure that the clarification developed in response to Order No. 693 is made to the FAC Reliability Standards as well. Ameren's comments concerning the operational timeframe do not affect FAC-010-1, which concerns the planning time frame. 42 Order No. 693 at P 1788. 43 *Id.* P 1792 & n.460 and 1794 (stating “on the record before us, we believe that the transmission planning Reliability Standard should not allow an entity to plan for the loss of non-consequential load in the event of a single contingency”). 3. Loss of Shunt Device 54. The NOPR requested comment on Requirement R2.2 of FAC-010-1 and the corresponding Requirement R2.2 of FAC-011-1, which include the loss of a shunt device among the various single contingencies that a planning authority must address. 44 The NOPR noted that although the TPL Reliability Standards implicitly require the loss of a shunt device to be addressed, they do not do so explicitly. Therefore, the NOPR requested comment whether NERC should revise the TPL Reliability Standards to be consistent with FAC-010-1 and FAC-011-1 by explicitly requiring the consideration of a shunt device. 44 NOPR at P 23, 33. Comments 55. NERC explains that although the TPL Reliability Standards sets the foundation for the types of contingencies to be considered for the FAC Reliability Standards. While the FAC Reliability Standards were developed after TPL-001-0, TPL-002-0, TPL-003-0 and TPL-004-0 were approved by the NERC board, NERC and Southern report that the FAC Reliability Standards drafting team recognized that TPL Table 1 needed clarity. Accordingly, NERC states that the drafting team modified the language from Table 1 in an effort to add clarity. According to NERC, the intent of the FAC Reliability Standard drafting team was to use the TPL contingencies as the definitional basis for SOL determination. Moreover, NERC states that the contingencies used in the FAC Reliability Standards are consistent with the contingencies identified in the TPL Reliability Standards, with the exception of the shunt device noted. 56. NERC notes that the TPL Reliability Standards are currently under revision. As the TPL Reliability Standards are modified, NERC states that conforming changes may need to be made to the FAC Reliability Standards to maintain consistency between the TPL Reliability Standards and the FAC Reliability Standards. At this time, NERC does not recommend modifying the TPL Reliability Standards to include a specific reference to shunt devices based on these FAC Reliability Standards and states that such a Commission directive is not necessary. 57. Commenters disagree whether the TPL Reliability Standards should be updated to address the loss of a shunt devise. Ameren and ISO/RTO Council state that the TPL requirements should be clarified to address shunt devices, while NRECA does not believe that a loss of a shunt device should be specifically named as a single contingency in the TPL Reliability Standards. Furthermore, NRECA believes that such a determination is within the ERO's technical expertise, is entitled to due weight and should therefore be pursued by the ERO, rather than the Commission. Commission Determination 58. As discussed, the FAC Reliability Standards explicitly reference shunt devices as one of the contingencies to be examined in setting SOLs, whereas the TPL Reliability Standards do not explicitly reference shunt devises. NERC reports that this difference is a result of administrative lag in the preparation of the lists of single contingencies to be accounted for in analyses under the two sets of Reliability Standards. Based on NERC's statement that it is currently addressing disparate treatment of shunt devices by revising the appropriate TPL Reliability Standards through the Reliability Standards development process, we will accept Requirement R2.2 of FAC-010-1 and Requirement R2.2 of FAC-011-1. Given the current efforts to promote consistency among planning, operations and TTC calculations and assumptions, the Commission expects NERC to address any inconsistencies in the treatment of shunt devices in revised TPL Reliability Standards. In the event that an alternative approach is developed and proposed by the ERO, NERC is required to provide an adequate justification for any differing treatment among the particular facilities considered in the various Reliability Standards. 4. Load Forecast Error Under FAC-011-1 59. As described in the NOPR, Requirement R2.3.2 of FAC-011-1 provides that the system's response to a single contingency may include, *inter alia,* “[i]nterruption of other network customers, only if the system has already been adjusted, or is being adjusted, following at least one prior outage, or, if the real-time operating conditions are more adverse than anticipated in the corresponding studies, *e.g.* , load greater than studied.” 45 In the NOPR, the Commission requested that NERC clarify the meaning of the phrase “if the real-time operating conditions are more adverse than anticipated in the corresponding studies, *e.g.* , load greater than studied.” In particular, the Commission questioned whether this provision treats load forecast error as a contingency and would allow an interruption due to an inaccurate weather forecast. 45 NOPR at P 25. Comments 60. NERC states that deviations between anticipated conditions and real-time conditions, such as load forecast errors, are not contingencies by definition in the NERC glossary. However, in real-time, the operators must take the actions necessary to maintain bulk electric system reliability given current conditions. Available actions include load shedding if operating conditions warrant. 61. NERC states that when the real-time operating conditions do not match the assumed studied conditions, the deviation can reach a magnitude such that the operator must take actions different from those anticipated by the study. From that perspective, the study error has the same affect on the bulk electric system as many actual contingencies. While these deviations do not meet the approved definition of a “contingency” in NERC's glossary, NERC states that system operators need to react to these unexpected circumstances expeditiously and interruption of other network customers is allowed and expected if conditions warrant such an action. NERC maintains that this provision is necessary to ensure that system operators have the ability to shed load without penalty to preserve the integrity of the bulk electric system. Thus, while it does not classify and study forecast error as a “contingency,” NERC asserts that a significant gap between actual and studied conditions (such as a large error in load forecast) can be treated as though it were a contingency under the proposed Reliability Standard. 62. NERC states that all anticipatory studies must begin with a reasonable set of assumptions. 46 According to NERC, when “real time” approaches that time period that was assessed by the particular anticipatory study, real time conditions may not replicate the predicted state. For example, unscheduled transmission outages may have occurred, generation outages may have occurred, the system could be operating with one or more Transmission Loading Relief procedures or other congestion management action such as redispatch in effect requiring a different generation dispatch than anticipated when the applicable study was being conducted. Moreover, the actual load level and load diversity could be different than forecasted and used in the corresponding study, or the transmission facility loading levels could be significantly higher than studied because any of or all of the conditions above—either on the system being studied or on near-by systems. 46 *See* NERC Comments at 26. NERC states that these assumptions would include:
(1)*Existing* and scheduled transmission outages for that time period,
(2)existing and scheduled generation outages for that time period,
(3)projected generation dispatch for that time period,
(4)predicted status of voltage control devices, and
(5)load level and load diversity for the future time period being scheduled. 63. NERC asserts that FAC-011-1, Requirement R2.3.2 allows interruption of network customers following a contingency and in anticipation of the next potential unscheduled event if the real-time operating conditions are more adverse than anticipated. The adjustment in response to an unscheduled outage or load forecast error, for example, would be to return to a reliable state, recognizing the conditions as they exist at the time—available generation, transmission configuration, available reactive resources, load level and load diversity, and conditions on other systems. 64. Similarly, FirstEnergy argues that no change should be made, because FAC-011-1 is intended to permit a system operator to implement the best reliability response, but does not require an inquiry into the cause of system conditions. 65. ISO/RTO Council views “load greater than studied” as providing an example of when “real-time operating conditions are more adverse than studied,” not as a qualifier of that language. ISO/RTO Council does not support treating load forecast error as a contingency. While load forecast error may be unpredicted, normally time is available for adjustments. Commenters note that operating reserve requirements should provide sufficient margin for error, as reflected in the NERC glossary. 47 47 *See, e.g.* , ISO/RTO Council and NRECA Comments. 66. Southern and NRECA comment that load forecast error is not a contingency, but is a failure in one element of the data that make up the day-ahead study base case. The day-ahead study is used to identify contingencies where reliability criteria may not be met (that is, SOLs are exceeded). Southern argues that the purpose of this process is to lessen the potential for problems occurring in real time. The day-ahead study is used to schedule resources and outages, and adjustments are made in real time as actual conditions differ from forecasted conditions. To respond to changing conditions, a system operator may rely on switching procedures, redispatch, curtailments and load shedding, but load shedding should be avoided. 67. NRECA argues that, because the matter is technical, it should be addressed by the ERO, through the Reliability Standards development process and not through a Commission rulemaking. Ameren notes that other load shedding conditions exist and suggests that the list of examples be expanded or that the specific reference to load forecast errors be removed to avoid confusion. Duke maintains that the phrase, “or if real-time operating conditions are more adverse than anticipated in the corresponding studies, *e.g.* , load greater than studied,” should be deleted because the focus of Requirement R2.3.2 is that a response to a second contingency may include interruption of non-consequential load, while extreme weather, while a possibility, is unrelated to SOL methodology or contingencies. Commission Determination 68. The Commission agrees with Southern, NRECA and ISO/RTO Council that load forecast error is not a contingency and should not be treated as such for the purposes of complying with mandatory Reliability Standards. NERC has failed to support its assertion that a significant gap between actual and studied conditions (such as a large error in load forecast) can be treated as though it were a contingency under the proposed Reliability Standard. While such a situation may cause unanticipated contingencies to become critical, correcting for load forecast error is not accomplished by treating the error as a contingency, but is addressed under other Reliability Standards. For instance, transmission operators are required to modify their plans whenever they receive information or forecasts that are different from what they used in their present plans. Furthermore, variations in weather forecasts that result in load forecast errors are more properly addressed through operating reserve requirements. 48 Once the operating reserve is activated, BAL-002-0 requires correction through system adjustments to alleviate reliance on operating reserves within 90 minutes rather than treating the incorrect forecast as a contingency. 49 NERC's interpretation could be used to justify not taking timely emergency action prior to load shedding, or to influence how other Reliability Standards are interpreted, which could result in moving to “lowest common denominator” Reliability Standards. 48 *See, e.g.* , NERC, Request for Approval of Reliability Standards, Glossary of Terms Used in Reliability Standards, at 12 (April 4, 2006) (April 2006 Reliability Standards Filing) (defining Operating Reserve as “That capability above firm system demand required to provide for regulation, *load forecast errors* , equipment forced and scheduled outages and local area protection. It consists of spinning and non-spinning reserves” (emphasis added)). 49 *See* Reliability Standard BAL-002-0, sub-Requirements R4.2 and R6.2. *See also* EOP-002-1 (requiring Energy Emergency Alert 1 to be declared if a balancing authority, reserve sharing group or load serving entity is concerned about sustaining its required Operating Reserves). 69. The Commission does not find that NERC's interpretation is required by the text of FAC-011-1, Requirement R2.3.2. When read in connection with Requirement R2.3, it is clear that the operating conditions “more adverse than anticipated,” referred to in sub-Requirement R2.3.2 are exacerbating circumstances that are distinct from the actual contingency to be addressed that is referred to in Requirement R2.3. It is the existence of the exacerbating circumstance in combination with a separate and distinct contingency that triggers the potential for an interruption of network customers in R2.3.2. However, that reading does not support treating “load greater than studied” as a contingency. [E T="03"]See[/E] Reliability Standard BAL-002-0, sub-Requirements R4.2 and R6.2. See also EOP-002-1 (requiring Energy Emergency Alert 1 to be declared if a balancing authority, reserve sharing group or load serving entity is concerned about sustaining its required Operating Reserves). 70. The Commission disagrees with NERC's reading of sub-Requirement R2.3.2 and interpretation of the phrase “load greater than studied.” However, the Commission finds that the meaning of Requirement R.2.3 and sub-Requirement R.2.3.2 is not otherwise unclear. Therefore, keeping with our approach in this Final Rule, we approve FAC-011-1, but direct NERC to revise the Reliability Standard through the Reliability Standards development process to address our concern. This could, for example, be accomplished by deleting the phrase, “e.g., load greater than studied” from sub-Requirement R.2.3.2. 71. Ameren requests that the Commission consider a new issue not raised in the NOPR. Ameren should raise its concern with NERC in the Reliability Standards development process. 5. Other Issues 72. Midwest ISO requests that the Commission reject FAC-010-1 because calculations for the 5 to 10 year planning horizon do not provide useful guidance on potential expansions to planners or system operators. Midwest ISO supports the use of SOLs and IROLs in the operating horizon to properly secure the system but notes that, in the long-term planning horizon, SOLs and IROLs are used to identify system vulnerabilities, which may then be addressed in short-term operating studies. Midwest ISO states that operational data may be fed into models to ensure that no limits are reached and that the system can operate safely given the projected uses, outages and resources. However, Midwest ISO argues that developing SOLs and IROLs in the long-term planning horizon would not be useful, since there is no reason to believe that interface transfer limits, so calculated, would ever be reached or utilized in real time operations. 73. Midwest ISO supports a requirement for appropriate operational studies and cites an example examining the feasibility of a 1,000 MW projected interchange based on expected loads, resources and firm transactions. However, Midwest ISO does not see value in additional studies to determine the ultimate MW transfer limits in a similar interchange, because the system operator could not justify use of the facilities to achieve limits that are well beyond current system needs. Midwest ISO asserts that other planning processes, such as new generation deliverability studies or transmission feasibility studies are the appropriate means to accommodate requests for higher transfer limits. 74. NYSRC and NYISO maintain that Requirement R2.4 of FAC-011-1 should require consideration of credible multiple element Category C contingency events for determining SOLs for the operating horizon, similar to Requirement R2.4 in FAC-010-1. 50 According to NYSRC and NYISO, failure to consider this class of contingencies in determining SOLs during the operating horizon will compromise the reliability of the Bulk-Power System and weaken system reliability. NYSRC and NYISO maintain that FAC-011-1 does not require a reliability coordinator to operate the real time system within SOLs determined from credible multiple contingency scenarios. 51 50 Requirement R2.4 of FAC-010-1 states “with all facilities in service and following multiple Contingencies identified in TPL-003 the system shall demonstrate transient, dynamic and voltage stability; all Facilities shall be operating with their Facility Ratings and within their thermal, voltage and stability limit; and Cascading Outages or uncontrolled separation shall not occur.” 51 *See* NYSRC and NYISO Comments at 4-5. 75. NYSRC and NYISO assert that they raised this issue with the Reliability Standards drafting team and that NYSRC and NYISO disagree with the drafting team about the result of considering credible multiple element contingency events for determining SOLs for the operating horizon. Further, they argue that FAC-011-1 is not consistent with the Blackout Report recommendation that NERC should not dilute the content of its existing Reliability Standards because FAC-011-1 is less stringent than prior practices in the Northeast and other regions. Other commenters request the Commission to reject the FAC Reliability Standards to permit NERC to address outstanding issues reflected in their pleadings. 52 52 *See* , *e.g.* , NRECA Comments, Ameren Comments at 6 (arguing that the Commission should not accept Reliability Standards imposing conflicting obligations and should direct NERC to monitor interrelated Reliability Standards for consistency). Commission Determination 76. The Commission finds that the Midwest ISO and NYSRC and NYISO have failed to raise any objection to the FAC Reliability Standards that would justify withholding our approval. Specifically, we note that Midwest ISO operates location-based marginal pricing markets using economic dispatch. Consequently, despite the fact that it may not rely on path-based transmission planning based on facility or path ratings, the FAC Reliability Standards would not prevent Midwest ISO from performing appropriate planning for its system. To the extent that it seeks an accommodation for its planning processes it may seek a regional difference or other accommodation through the Reliability Standards development process. As identified by NERC in its comments, the SOLs developed pursuant to FAC-010-1 will be an input to calculating long-term ATC as required by Order Nos. 890 and 693. 53 53 NERC Comments at 7. 77. SOLs are also used by transmission providers to provide details to system users concerning available capacity for transmission service and to communicate justifications for denials of service requests, including long-term ATC. Transmission owners are required to make long-term TTC calculations in accordance with Order Nos. 890 and 693. 78. To the extent that Midwest ISO requests that the Commission consider new issues not raised in the NOPR, the Commission's general practice is to direct that such comments be addressed in the NERC Reliability Standards development process. In Order No. 693, the Commission noted that various commenters provided specific suggestions to improve or otherwise modify a Reliability Standard to address issues that were not raised in the Commission's NOPR addressing that Reliability Standard. In those cases, the Commission directed the ERO to consider such comments when it modifies the Reliability Standards according to NERC's three-year review cycle. The Commission, however, does not direct any outcome other than that the comments receive consideration. 54 We direct a similar treatment to address the issue raised in the Midwest ISO's comments. 54 *See* Order No. 693 at P 188; Order No. 693-A at P 118. 79. The Commission does not agree with NYSRC and NYISO's suggestion that FAC-011-1 must be revised so that SOLs for the operating horizon are determined based on both single and multiple contingencies. The FAC-011-1 methodology already requires the reliability coordinator to determine SOLs by considering both the multiple contingencies provided by the planning authority that could result in instability of the Bulk-Power System and the facility outages and minimum set of single contingencies that were previously considered. Requirements R3.3 and R4 direct each reliability coordinator to determine which stability limits arising from multiple contingencies it will apply and convey that information to other reliability coordinators, planning authorities and transmission operators. The list of multiple contingencies is supplied by the planning authority and is applicable for use in the operating horizon given the actual or expected system conditions. This is consistent with the Commission's directives in Order No. 693. 55 If NYSRC and NYISO are concerned that the multiple contingency list is not adequate, they should raise those concerns in the Reliability Standards development process. 55 *See id* . P 1601-03. 6. Effective Date 80. In the NOPR, the Commission proposed to approve FAC-010-1, FAC-011-1 and FAC-014-1 as mandatory and enforceable Reliability Standards, consistent with NERC's original implementation plan beginning July 1, 2007 for Reliability Standard FAC-010-1; October 1, 2007 for FAC-011-1 and January 1, 2008 for FAC-014-1. Comments 81. In its September 2007 comments, NERC requested that the Commission adopt updated effective dates of July 1, 2008 for FAC-010-1, October 1, 2008 for FAC-011-1 and January 1, 2009 for FAC-014-1. NERC explains that the proposed phased implementation schedule will provide each responsible entity sufficient time to determine stability limits associated with multiple contingencies, to update the system operating limits to comply with the new requirements, to communicate the limits to others, and to prepare the documentation necessary to demonstrate compliance. 82. No commenter objected to NERC's proposal to use staggered effective dates to implement the three Reliability Standards. However, Ontario IESO notes that FAC-010-1 and FAC-011-1 became effective in Ontario, Canada on October 1, 2007, making implementation of the Reliability Standards in Ontario and the United States inconsistent so long as the Commission delays approval or remands the Reliability Standards. Commission Determination 83. The Commission agrees that it is appropriate in this instance to adopt NERC's revised effective dates of July 1, 2008 for FAC-010-1, October 1, 2008 for FAC-011-1 and January 1, 2009 for FAC-014-1. Given that this Final Rule will not be effective until January 2008, it is reasonable to allow responsible entities in the United States adequate time to comply with these Reliability Standards. 84. As for Ontario IESO's concerns with the different implementation dates in Ontario and the United States, we agree that effective dates should be coordinated if practicable. In these circumstances, however, we foresee no problems arising from the effective dates approved here. C. Western Interconnection Regional Difference 85. FAC-010-1 and FAC-011-1 each identify a list of contingencies to be studied in developing SOLs. 56 Each of these Reliability Standards includes a regional difference for the Western Interconnection containing a different list of multiple contingencies from those to be considered in other regions (which are derived from Table 1 in the TPL Reliability Standards series). The NOPR observed that the detailed list of considerations and contingencies in the regional differences for the Western Interconnection appears to be more stringent and detailed than the set of contingencies provided for in FAC-010-1 and FAC-011-1. The regional differences require WECC to evaluate multiple facility contingencies when developing SOLs under FAC-010-1 and FAC-011-1. The Commission proposed to approve the WECC regional difference for establishing SOLs. 57 56 *See* FAC-010-1, Requirement 2.2 and FAC-011-1, Requirement 2.2. 57 NOPR at P 18-19 (citing Order No. 672 at P 290-91). 86. However, the Commission expressed its concern that the regional difference provides that the Western Interconnection may make changes to the contingencies required to be studied or required responses to contingencies but does not specify the procedure for doing so. The regional difference states: The Western Interconnection may make changes (performance category adjustments) to the Contingencies required to be studied and/or the required responses to the Contingencies for specific facilities based on actual system performance and robust design.[ 58 ] 58 *See* , *e.g.* , FAC-011-1, section E.1.4 (incorporating the WECC regional difference). 87. The regional differences do not identify any process for making such changes or indicate whether the requirements for reasonable notice and opportunity for public comment, due process, openness and balance of interests will be met. 59 Accordingly, the NOPR proposed that WECC identify its process to revise the list of contingencies and requested comment whether the regional difference should state the process. 59 NOPR at P 20 ( *citing* FPA section 215(c)(2)(D), 16 U.S.C. 824o(c)(2)(D) (2000 & Supp. V 2005)). Comments 88. WECC explains that it has a process to evaluate probabilities for single contingencies and adjust performance requirements for facilities, known as the “Seven Step Process for Performance Category Upgrade Request” (Seven Step Process). 60 WECC states that the Seven Step Process is a “stand-alone” process that is used for evaluating the probability of an event on a single facility and for adjusting performance requirements of that facility. According to WECC, the Seven Step Process applies to individual facilities and not entire “outage categories.” 60 WECC Comments at 4 and Attachment A. 89. WECC states that the Seven Step Process was adopted after full due process at the WECC Planning Coordination Committee level and when it was approved by the WECC board of directors. WECC describes its process through which it will review an applicant's “request [for] a change to a path's performance Category level.” 61 The performance category level is an outage performance standard assigned to each path under the WECC planning standards. 62 The Seven Step Process is largely a technical description of the proposed change, which includes a single page workflow diagram describing the approval procedures. 63 61 Seven Step Process at 1. 62 *Id* . 63 *Id.* , Attachment B. 90. NERC describes the WECC process as a stand-alone process used for evaluating the probability of an event on a single facility and for adjusting performance requirements of that facility, that is not used to determine which categories of events are to be considered when rating facilities or for adjusting performance requirements of entire categories. 91. WECC states, while it does not object to including appropriate language in the regional difference describing generally the criteria modification process, it prefers not to have the regional differences specifically modified to include the Seven Step Process. WECC expresses concern that, if included in the Reliability Standards, changes to the Seven Step Process would then be made through the NERC ballot body process rather than the WECC Reliability Standards Development process. 92. Santa Clara comments that the contingency revision process should be open and states the WECC regional difference should explicitly state the process. Commission Determination 93. In the NOPR, we noted that Order No. 672 explains that “uniformity of Reliability Standards should be the goal and the practice, the rule rather than the exception.” 64 As a general matter, the Commission has stated that regional differences are permissible if they are either more stringent than the continent-wide Reliability Standard or if they are necessitated by a physical difference in the Bulk-Power System. 65 Regional differences must still be just, reasonable, not unduly discriminatory or preferential and in the public interest. 66 64 Order No. 672 at P 290. 65 *Id* . P 291. 66 *Id* . 94. No party has objected to the operative provisions of the WECC regional difference. Furthermore, the regional difference contains terms that are more stringent than the requirements established for the rest of the continent. Therefore, consistent with Order No. 672, the Commission approves the WECC regional differences for FAC-010-1 and FAC-011-1, incorporating separate lists of contingencies to be considered in the Western Interconnection. 95. WECC's explanation of its Seven Step Process adequately addresses the Commission's concerns stated in the NOPR. The Commission was concerned that the language of the WECC regional difference would, in effect, allow WECC to revise the content of a mandatory and enforceable Reliability Standard without the approval of the ERO or the Commission. WECC makes clear that that is not the case. WECC explains that the intent of the regional difference is not to allow WECC to change or adjust entire category performance requirements. Rather, the intent is to evaluate the probability of an event on a single facility and adjust performance requirements of that facility. WECC states that this evaluation could result in performance requirements for the outage of a specific facility “more or less stringent based on the probability of that outage on that facility.” 67 67 WECC at 4. 96. Further, the Seven Step Process, developed after a fair and open vetting at the Regional Entity, appears to provide adequate due process for the entity responsible for the performance of the facility that is the subject of a particular “adjustment.” Presumably, this process would also provide sufficient documentation of the change so that, for example, an auditor would have the ability to identify the change and evaluate an entity's performance with the regional standard taking the change into consideration. The Commission finds that it is not necessary to modify the regional differences to expressly mention the Seven Step Process. Accordingly, the Commission approves the WECC regional difference for the reasons discussed above. Our approval is made with the understanding any WECC-approved change would not result in less stringent criteria for Western Interconnection facilities than those defined in the main body of FAC-010-1 and FAC-011-1. D. New Glossary Terms 97. NERC proposes to add or revise four terms in the NERC glossary, Cascading Outages, Delayed Fault Clearing, Interconnection Reliability Operating Limit
(IROL)and Interconnection Reliability Operating Limit T v (IROL T v ). The Commission stated in the NOPR that there could be multiple interpretations of some of these terms. 68 Therefore, the Commission proposed to clarify the terms Cascading Outages, IROL, and IROL T v , as discussed below. With the exception of the proposed definition of Cascading Outages, which we remand, the Commission approves the proposed definitions, as discussed below. 68 NOPR at P 38-43. 1. Cascading Outages 98. Although the glossary does not currently include a definition of Cascading Outage, it includes the following approved definition of Cascading: *Cascading:* The uncontrolled successive loss of system elements triggered by an incident at any location. Cascading results in widespread electric service interruption that cannot be restrained from sequentially spreading beyond an area predetermined by studies.[ 69 ] 69 April 2006 Reliability Standards Filing, Glossary at 2. NERC proposes the following new definition of Cascading Outages: *Cascading Outages:* The uncontrolled successive loss of Bulk Electric System facilities triggered by an incident (or condition) at any location resulting in the interruption of electric service that cannot be restrained from spreading beyond a pre-determined area. 99. The NOPR stated that the extent of an outage that would be considered a cascade is ambiguous in the current term Cascading. The Commission noted that the new definition of Cascading Outages includes a similar phrase “a pre-determined area,” which may lead to different interpretations of the extent of an outage that would be considered a Cascading Outage. In the NOPR, the Commission stated that it understands that this phrase could be interpreted to refer to a scope as small as the elements that would be removed from service by local protective relays to as large as the entire balancing authority. The Commission objected to the possibility that the Cascading Outages definition might consider the loss of an entire balancing authority as a non-cascading event. The NOPR sought comment on the Commission's proposal to accept the glossary definition but clarify the scope of an acceptable “pre-determined area.” Such an area would not extend beyond “the loss of facilities in the bulk electric systems that are beyond those that would be removed from service by primary or backup protective relaying associated with the initiating event.” Comments 100. NERC, EEI and APPA, Ameren, Duke, PG&E, Southern and Xcel disagree with the Commission's interpretation of the term Cascading Outages. While FirstEnergy, Southern and MidAmerican agree that NERC's proposed definition of Cascading Outages may be open to interpretation, they also object to the Commission's interpretation of the term. Several commenters, including Duke, NRECA and Ameren, assert that the Commission's proposal is overly prescriptive. 101. According to NERC, as well as EEI and APPA, the term was designed to provide a classification for an event, not to identify attributes of an event such as scope, risk or acceptable impact. As EEI and APPA understand the term, Cascading Outages will be used to describe facts and circumstances in the analysis of widespread uncontrolled outages that take place when there are unexpected equipment failures or strong electrical disturbances. The analyses of these highly unusual and large-scale events, however, will take place through processes described in the NERC Rules of Procedure. EEI and APPA maintain that the key to NERC's proposed definition of Cascading Outages is “uncontrolled” and that the scope of the outage is unknown. 102. NERC agrees with the Commission's concern that the definition of Cascading Outages was not intended to allow for the loss of an entire balancing authority unless such an area conforms to the area predetermined by studies. However, commenters maintain that there are additional safety nets that are intended to confine an outage to a pre-set area of the bulk electric system, including special protection systems, protective relays, remedial action schemes, and underfrequency and undervoltage load shedding applications. According to commenters, the Commission's proposed interpretation appears to ignore the role of transmission operators in managing and containing outage situations and the use of these systems. 70 70 *See* , *e.g.* , NERC, EEI and APPA, and Duke Comments. 103. ISO/RTO Council notes that system planning studies examining the extent of outages anticipate the operation of protective relay options providing primary protection, with backup protective relays provided by “secondary protection, zone 2 protection and special protection systems.” ISO/RTO Council requests a clarification as to what backup protective relaying means and whether or not planned operation of a special protection system to contain impacts of outages is regarded as backup protection. 104. Several commenters maintain that the Commission's proposed interpretation of the term Cascading Outages is too broad. NERC, Ameren, PG&E, Southern, and EEI and APPA assert that this interpretation would result in too many outages being defined as Cascading Outages under the Commission's interpretation. They maintain that even an outage that is contained exactly as planned could be designated as a Cascading Outage. Further, NERC states that the implication of applying the Commission's definition to the TPL evaluations required in Table 1 would be extraordinary in scope and impact and the cost would be prohibitive. Additionally, NERC and Southern state that the Commission's interpretation is in conflict with Table 1 in the TPL-001-0 through TPL-004-0 Reliability Standards that the Commission approved in Order No. 693. 105. NERC, therefore, recommends that the Commission reconsider its proposal to accept and interpret the term Cascading Outages. According to NERC, adoption of the Commission's proposed understanding would require a review of all NERC Reliability Standards that rely on the Cascading Outages definition to be certain that the intent of the Reliability Standards does not also change. If the definition of Cascading Outages needs to be changed, several commenters, including NERC, FirstEnergy and Southern, maintain that changes should be made through NERC's stakeholder process. Some commenters offer alternative definitions or clarifications for Cascading Outages. 71 71 *See* Duke, ISO/RTO Council and MidAmerican Comments. 106. Ameren disagrees that the proposed phrase “beyond a pre-determined area” would invite system users to expand or contract their understanding of such an area without limit. Ameren argues that the concern that the pre-defined area be defined as too small is unfounded because the existing definition already requires that the outage not be local in nature, that is, result in outages beyond the site of the initial failure. Furthermore, the definition cannot be defined too large, since the scope for operation and planning authorities is already established. 107. Similarly, PG&E and Southern argue that the Commission's proposal is not necessary, because the Reliability Standards address outages in relation to the severity of their impact on the grid. PG&E maintains that the Reliability Standards limit application of the definition to an entire balancing authority, because the Reliability Standards require a technical analysis of the appropriate boundary, and distribution of the methodology used to define a “predetermined area.” Therefore, according to PG&E, such a “predetermined area” could only be defined to mean the loss of an entire balancing authority when technically appropriate. 108. MidAmerican requests that the Commission direct NERC to re-focus planning Reliability Standards away from the ambiguous definition of cascade and develop a definition based on maximum loss of load allowed for a given contingency, such as 1,000 MW. MidAmerican supports its 1,000 MW threshold as being a significant loss, while not exceeding the load for most balancing authorities. 109. Southern argues that as written, the phrase “that adversely impact the reliability of the bulk electric system” modifies Cascading Outages and not a violated system operating limit. Southern proposes that the phrase should be left in because it codifies an appropriate distinction between Cascading Outages that affect reliability and other localized events that create a controlled separation that do not impact the reliability of the system. 110. Xcel is concerned that the Commission's comments indicate an intent to restrict the use of controlled outages to prevent the escalation of system contingencies. Xcel states that the Commission's proposed definition represents a departure from historical interpretation and application of the term and could have significant unintended consequences. Commission Determination 111. The Commission will not adopt the proposed interpretation of Cascading Outages contained in the NOPR. Rather, for the reasons discussed below, we remand the term Cascading Outages. If it chooses, NERC may refile a revised definition that addresses our concerns. 112. The present definition of Cascading provides that “[c]ascading results in widespread electric service interruption that cannot be restrained from sequentially spreading beyond an area *predetermined by studies* .” In contrast, the proposed definition of Cascading Outages describes an interruption “that cannot be restrained from spreading beyond a *pre-determined area* .” Although the language is somewhat similar, it removes the qualifying language “by studies.” NERC provides no explanation for this change. The Commission is concerned that the removal of this phrase in the definition of Cascading Outage would allow an entity to identify a “predetermined area” based on considerations other than engineering criteria. For example, under the proposed definition of Cascading Outages, an entity could predetermine that an outage could spread to the edge of its footprint without considering the event to be a Cascading Outage. The Commission is concerned that the limits placed on outages should be determined by sound engineering practices. 113. Adding to the ambiguity, NERC has provided definitions of Cascading and Cascading Outages that seem to describe the same concept—uncontrolled successive loss of elements or facilities—but did not explain any distinction between the two terms. Nor did NERC explain why the new term is necessary and requires a separate definition. Because NERC did not describe either the need for two definitions that seem to address the same matter or the variations between the two, the Commission remands NERC's proposed definition of Cascading Outages. 114. If NERC decides to propose a new definition of Cascading Outages, the Commission would expect any proposed definition to be defined in terms of an area determined by engineering studies, consistent with the definition of Cascading. In addition, the Commission is concerned with the consistent, objective development of criteria with which the “pre-determined area” would be determined. Therefore, the Commission suggests that NERC develop criteria, to be found in a new Reliability Standard or guidance document, that would be used to define the extent of an outage, beyond which would be considered a Cascading Outage. 115. Further, the terms Cascading and Cascading Outages contain other nuanced differences. For example, the “loss of system elements” is changed to “loss of Bulk Electric System facilities” and “triggered by an incident” is changed to “triggered by an incident (or condition).” The implications of these changes are not clear to the Commission. Accordingly, if NERC submits a revised definition of Cascading Outage, it should explain the purpose and meaning of changes from the term Cascading. 116. Given the concerns raised by commenters that the extent of an outage may vary, the Commission will not grant at this time MidAmerican's request to direct NERC to re-focus planning Reliability Standards away from the definition of cascade. Further, MidAmerican requests that the Commission consider new issues not raised in the NOPR. MidAmerican should raise these issues in the NERC Reliability Standards development process. 117. In response to ISO/RTO Council's request, the Commission clarifies that by “backup protective relaying,” the NOPR intended the compliance guidance to be consistent with Table 1 of the TPL Reliability Standards. Table 1 identifies the categories, contingencies, and system limits or impacts for normal and emergency conditions on the bulk electric system. A common requirement for each of the category A, B and C contingencies found in Table 1 is that after all of the system, demand and transfer impacts have been accommodated for specific contingencies, there will not be cascading outages of the bulk electric system. Since all of the planned and controlled aspects have been accommodated in this table, anything beyond these planned and controlled aspects should be a cascading outage. 2. IROL 118. The approved definition of IROL in the NERC glossary is: The value (such as MW, MVar, Amperes, Frequency or Volts) derived from, or a subset of the System Operating Limits, which if exceeded, could expose a widespread area of the Bulk Electric System to instability, uncontrolled separation(s) or cascading outages. 72 72 April 2006 Reliability Standards Filing, Glossary at 7. NERC proposes to modify the definition to state: *Interconnection Reliability Operating Limit (IROL):* A system operating limit that, if violated, could lead to instability, uncontrolled separation, or Cascading Outages that adversely impact the reliability of the bulk electric system. 119. The NOPR proposed to accept the revised definition of IROL with the understanding that all IROLs impact bulk electric system reliability. 73 The Commission stated that it was concerned that the revised IROL definition could be interpreted so that violations of some IROLs that do not adversely impact reliability are acceptable, due to exceptions based on the phrase “that adversely impacts the reliability of the bulk electric system.” The NOPR indicated that the revised definition is otherwise consistent with the intent of the statute. 73 NOPR at P 42. Comments 120. NERC, EEI and APPA, WECC and ISO/RTO Council agree with the Commission's interpretation of the definition of IROL. NERC states that an appropriate reading of the IROL definition does require that it impact reliability; otherwise it is not an IROL. The IROL definition does not suggest that there is a subclass of IROLs that do not impact reliability. Ameren supports the clarification and suggests that the phrase “that will adversely affect the reliability of the Bulk-Power System” should be deleted so that all IROLs are treated the same. 121. Although EEI and APPA agree with the Commission, they respectfully suggest that the Commission in the future defer initially to NERC on matters of technical interpretation. 122. SoCal Edison suggests that the IROL definition be revised to add the words “across an interconnection” after the initial phrase “[a] system operating limit” to clarify that an IROL relates to an SOL across a transmission operator's “area, interconnection or region.” Commission Determination 123. As proposed in the NOPR, the Commission accepts NERC's definition of IROL. In response to EEI and APPA, the Commission believes that, where a potential ambiguity exists, it is appropriate to clarify what the Commission believes it is approving. In Order No. 693, the Commission approved the proposed Reliability Standards with certain clarifications. 74 The Commission does not intend to unilaterally modify definitions; however, the Commission must ensure that it correctly understands NERC's intent while giving “due weight” to the technical expertise of the ERO. 75 Promoting such clarity is an important aspect of approving both Reliability Standards and glossary terms. 74 Order No. 693 at P 278 (“The Commission finds that these Reliability Standards, *with the interpretations provided by the Commission* in the standard-by-standard discussion, meet the statutory criteria for approval as written and should be approved”), P 1606 (“Commenters did not take issue with the proposed interpretation of the term ‘deliverability’ * * * The Commission adopts this proposed interpretation”). 75 *Id.* P 8 (citing section 215(d)(2) of the FPA and 18 CFR 39.5(c)(1),
(3)and stating “the Commission will give due weight to the technical expertise of the ERO with respect to the content of a Reliability Standard or to a Regional Entity organized on an Interconnection-wide basis with respect to a proposed Reliability Standard or a proposed modification to a Reliability Standard to be applicable within that Interconnection. However, the Commission will not defer to the ERO or to such a Regional Entity with respect to the effect of a proposed Reliability Standard or proposed modification to a Reliability Standard on competition.”). *See also* Order No. 672 at P 40. 124. With regard to SoCal Edison's concerns, these are new matters not raised in the NOPR that should be addressed in the NERC Reliability Standards development process. 3. IROL T v 125. The NOPR proposed to accept the proposed IROL T v definition. 76 However, the Commission noted that Order No. 693 identified two interpretations of when an entity exceeds an IROL. 77 The Commission stated that the definition of IROL T v does not distinguish between those two interpretations. Therefore, the Commission proposed to accept the definition of IROL T v with the understanding that the only time it is acceptable to violate an IROL is in the limited time after a contingency has occurred and the operators are taking action to eliminate the violation. 76 NOPR at P 43. *Interconnection Reliability Operating Limit T* v ( *IROL T* v ): The maximum time that an Interconnection Reliability Operating Limit can be violated before the risk to the interconnection or other Reliability Coordinator Area(s) becomes greater than acceptable. Each Interconnection Reliability Operating Limit's T v shall be less than or equal to 30 minutes. 77 *See* Order No. 693 at P 946 & n.303. Order No. 693 explained that IRO-005-1 could be interpreted as allowing a system operator to respect IROLs in two possible ways:
(1)*Allowing* IROL to be exceeded during normal operations, *i.e.* , prior to a contingency, provided that corrective actions are taken within 30 minutes, or
(2)exceeding IROL only after a contingency and subsequently returning the system to a secure condition as soon as possible, but no longer than 30 minutes. Comments 126. NERC agrees that the definition of IROL T v does not distinguish between the two possible interpretations of when an entity exceeds an IROL contained in Order No. 693. NERC, Ameren, and Southern agree with the Commission that the only time it is acceptable to violate an IROL is in the limited time after a contingency has occurred and the operators are taking action to eliminate the violation. WECC reports that this is consistent with WECC's interpretation. 127. The ISO/RTO Council disagrees that the only time an IROL can be exceeded is for a contingency. According to ISO/RTO Council, IROL T v should be less than or equal to 30 minutes with the understanding that the only time it is acceptable to violate an IROL is in the limited time after a contingency has occurred and the operators are taking action to eliminate the violation. ISO/RTO Council would, however, propose to expand this understanding to include the situation where no contingencies have occurred but the IROL is exceeded due to system condition changes, such as unanticipated external interchange schedules, redispatch, morning and evening load pick-up, or other events that cause a rapid change in transmission loading. Commission Determination 128. The Commission approves NERC's proposed definition of IROL T v based on the Commission's understanding explained in the NOPR and affirmed by NERC. ISO/RTO Council essentially seeks to expand the definition of IROL T v to apply to additional circumstances. This matter is best addressed by ISO/RTO Council in the NERC Reliability Standards development process. E. Violation Risk Factors 129. Violation Risk Factors delineate the relative risk to the Bulk-Power System associated with the violation of each Requirement and are used by NERC and the Regional Entities to determine financial penalties for violating a Reliability Standard. NERC assigns a lower, medium or high Violation Risk Factor for each mandatory Reliability Standard Requirement. 78 The Commission also established guidelines for evaluating the validity of each Violation Risk Factor assignment. 79 78 The specific definitions of high, medium and lower are provided in *North American Electric Reliability Corp.,* 119 FERC ¶ 61,145, at P 9 ( *Violation Risk Factor Order), order on reh'g* , 120 FERC ¶ 61,145
(2007)( *Violation Risk Factor Rehearing* ). 79 The guidelines are:
(1)Consistency with the conclusions of the Blackout Report;
(2)Consistency within a Reliability Standard;
(3)Consistency among Reliability Standards;
(4)Consistency with NERC's Definition of the Violation Risk Factor Level; and
(5)Treatment of Requirements that Co-mingle More Than One Obligation. The Commission also explained that this list was not necessarily all-inclusive and that it retained the flexibility to consider additional guidelines in the future. A detailed explanation is provided in *Violation Risk Factor Rehearing,* 120 FERC ¶ 61,145, at P 8-13. 130. In separate filings, NERC identified Violation Risk Factors for each Requirement of proposed Reliability Standards FAC-010-1, FAC-011-1 and FAC-014-1. 80 NERC's filings requested that the Commission approve the Violation Risk Factors when it takes action on the associated Reliability Standards. 80 *See* NERC, Request for Approval of Violation Risk Factors for Version 1 Reliability Standards, Docket No. RR07-10-000, Exh. A (March 23, 2007), as supplemented May 4, 2007. To date, the Commission has addressed only those Violation Risk Factors pertaining to the 83 Reliability Standards approved in Order No. 693. *Violation Risk Factor Order,* 119 FERC ¶ 61,145. 131. The NOPR proposed to approve most of the Violation Risk Factors for Reliability Standards FAC-010-1, FAC-011-1 and FAC-014-1. However, as discussed below, several of the Violation Risk Factors submitted for Reliability Standards FAC-010-1, FAC-011-1 and FAC-014-1 raise concerns. 1. General Issues Comments 132. Commenters generally oppose the Commission's proposal for raising the Violation Risk Factors. Further, they generally ask that changes to the Violation Risk Factors be made through the Reliability Standards development process. 133. Progress Energy maintains that violations associated with planning Reliability Standards cannot be high risk because such violations do not pose an imminent danger to the Bulk-Power System. Progress Energy contends that planning Reliability Standards are implemented over a long-term planning horizon. Progress Energy states that entities continually update load and other forecasts and assumptions relied on to determine future transmission and distribution system needs. As these assumptions change, so do the transmission plans. Progress Energy states that utilities provide constant oversight, frequent reviews, audits and evaluations of the planning process over the entire multi-year planning horizon. According to Progress Energy, with this type of control and oversight, it is highly unlikely that an inaccurate forecast or misassumption early in the planning horizon could result in an operational reliability concern. Consequently, planning authorities and reliability coordinators have adequate time to analyze, determine and correct planning violations before they could have an operational impact. 134. Progress Energy also states that unnecessarily increasing Violation Risk Factors for planning Reliability Standards may have unintended consequences. According to Progress Energy, assigning overly conservative Violation Risk Factors will cause planning and reliability coordinators to focus more time and resources on satisfying those Reliability Standards, potentially to the detriment of other Reliability Standards. It maintains that the level of the Violation Risk Factor is intended to communicate the importance of the Reliability Standards and, consequently, the resources that should be devoted to its implementation and the magnitude of the penalty associated with its violation. Further, to avoid potentially costly penalties associated with violation of higher risk factors, Progress Energy maintains that planning and reliability coordinators may take a more conservative approach with their assumptions, which could quite literally result in lower TTC and ATC determinations than would otherwise be available. Commission Determination 135. NERC submitted 72 Violation Risk Factors corresponding to the Requirements and sub-requirements in the three FAC Reliability Standards. The Commission, giving due weight to the technical expertise of NERC as the ERO, concludes that the vast majority of NERC's designations accurately assess the reliability risk associated with the corresponding Requirements and are consistent with the guidelines set forth in the Commission's prior orders addressing Violation Risk Factors. Therefore, the Commission approves 63 of these Violation Risk Factor designations. However, the Commission concludes that nine filed Violation Risk Factors for FAC Reliability Standards Requirements are not consistent with these guidelines and also concludes that one Requirement where no Violation Risk Factor was filed should have been assigned a Violation Risk Factor consistent with an identically worded Requirement from another FAC Reliability Standard. Thus, the Commission directs NERC to modify these ten Violation Risk Factors. 81 81 The ten Violation Risk Factors to which the Commission directs modification include Requirement R3.4 for FAC-011-1, where NERC did not assign a Violation Risk Factor. In this instance, the Commission assigns a Violation Risk Factor to the subject Requirement that is consistent with the Violation Risk Factor assigned to an identical Requirement for another Reliability Standard, FAC-010-1, Requirement R2.3. 136. NERC and other commenters, such as APPA and EEI, ask the Commission to defer to NERC on the determination of Violation Risk Factors and, instead, allow NERC to reconsider the designations using the Reliability Standards development process. The Commission has previously determined that Violation Risk Factors are not a part of the Reliability Standards. 82 In developing its Violation Risk Factor filing, NERC has had an opportunity to fully vet the FAC Violation Risk Factors through the Reliability Standards development process. The Commission believes that, for those Violation Risk Factors that do not comport with the Commission's previously-articulated guidelines for analyzing Violation Risk Factor designations, there is little benefit in once again allowing the Reliability Standards development process to reconsider a designation based on the Commission's concerns. Therefore, we will not allow NERC to reconsider the Violation Risk Factor designations in this instance but, rather, direct below that NERC make specific modifications to its designations. NERC must submit a compliance filing with the revised Violation Risk Factors no later than 90 days before the effective date of the relevant Reliability Standard. 82 *Violation Risk Factor Rehearing,* 120 FERC ¶ 61,145, at P 11-16, *citing North American Reliability Corp.,* 118 FERC ¶ 61,030, at P 91, *order on clarification and reh'g,* 119 FERC ¶ 61,046 (2007). 137. That being said, NERC may choose the procedural vehicle to change the ten Violation Risk Factors consistent with the Commission's directives. NERC may use the Reliability Standards development process, so long as it meets Commission-imposed deadlines. 83 In this instance, the Commission sees no vital reason to direct NERC to use section 1403 of its Rules of Procedure to revise the Violation Risk Factors below, so long as the revised Violation Risk Factors address the Commission's concerns and are filed no less than 90 days before the effective date of the relevant Reliability Standard. The Commission also notes that NERC should file Violation Severity Levels before the FAC Reliability Standards become effective. 83 *See North American Electric Reliability Corp.,* 118 FERC ¶ 61,030, at P 91, *order on compliance,* 119 FERC ¶ 61,046, at P 33 (2007). 138. In revising the Violation Risk Factors, NERC must address the Commission's concerns, as outlined below, and also follow the five guidelines for evaluating the validity of each Violation Risk Factor assignment. Consistent with the *Violation Risk Factor Order,* the Commission directs NERC to submit a complete Violation Risk Factor matrix encompassing each Commission-approved Reliability Standard and including the correct corresponding version number for each Requirement when it files revised Violation Risk Factors for the FAC Reliability Standards. 139. Progress Energy incorrectly claims that a planning Reliability Standard will never qualify for a high Violation Risk Factor. According to NERC, a high risk requirement includes:
(b)* * * a requirement *in a planning time frame* that, if violated, could, under emergency, abnormal, or restorative conditions *anticipated by the preparations,* directly cause or contribute to Bulk-Power System instability, separation, or a cascading sequence of failures, or could place the Bulk-Power System at an unacceptable risk of instability, separation, or cascading failures, or could hinder restoration to a normal condition [emphasis added]. 140. A Violation Risk Factor assigned to Requirements of planning-related Reliability Standards represent, in a planning time frame, the potential reliability risk, under emergency, abnormal, or restorative conditions anticipated by the preparations to the Bulk-Power System. As such, how much time a planning authority or reliability coordinator has to identify and correct a violation of a planning-related Requirement is irrelevant in the assignment of an appropriate Violation Risk Factor. 141. The Commission also disagrees with Progress Energy that overly conservative Violation Risk Factor assignments may result in the lowering of TTC and ATC determinations because planning and reliability coordinators may take a more conservative approach with assumptions to avoid potentially costly penalties. Progress Energy did not assert any specific deficiency regarding the relationship between planning Reliability Standards and TTC and ATC determinations. Because Violation Risk Factors do not determine the actions a responsible entity must take, but merely measure the risk of violating a Requirement to the reliability of the Bulk-Power System, it is the specific Requirements in a given Reliability Standard that establish the relationship between planning Reliability Standards and TTC and ATC determinations, not the assignment of a Violation Risk Factor. If Progress Energy has specific concerns that a Reliability Standard is having an unduly detrimental effect on TTC or ATC determinations, it should raise such issues in the Reliability Standards development process. Comments on WECC Violation Risk Factors 142. In the NOPR, the Commission noted that there are no Violation Risk Factors applicable to the WECC regional differences and that certain portions of the WECC regional differences lack levels of non-compliance. The NOPR requested comment on whether it should require WECC to develop Violation Risk Factors and the levels of non-compliance for the regional differences. The NOPR also requested comment on how WECC should assess penalties in the interim, if it were tasked with such a responsibility. 143. NERC states that WECC believes that it should be required to develop Violation Risk Factors for its regional differences. WECC indicates that it will initiate efforts to develop Violation Risk Factors for the regional differences identified in FAC-010-1 and FAC-011-1. In the interim, WECC proposes to assess penalties for non-compliance by adopting the same Violation Risk Factor for each WECC regional difference as is identified for NERC Requirements R2.4 and R2.5 for FAC-010-0 and Requirement R3.3 for FAC-011-1 that the WECC regional differences replace. It is WECC's intention to propose that the WECC regional differences should have the same Violation Risk Factors as NERC Requirements R2.4 and R2.5 in FAC-010-1 and Requirement R3.3 for FAC-011-1 when it goes through its process to develop the Violation Risk Factors. 144. WECC notes that levels of non-compliance already exist in section D.3 in both FAC-010-1 and FAC-011-1. For penalty calculations in the interim, before Violation Risk Factors and levels of non-compliance consistent with NERC's methodology are developed, WECC intends to apply the Violation Risk Factors established for NERC Requirements R2.4 and R2.5 for FAC-010-1 and Requirement R3.3 for FAC-011-1. 145. Santa Clara agrees that WECC should develop the Violation Risk Factors and levels of non-compliance for the WECC regional differences. Commission Determination 146. Furthermore, the Commission agrees that it is appropriate to permit WECC to develop the Violation Risk Factors that are applicable to the WECC regional differences. The Commission also takes note of WECC's proposal to assign the same Violation Risk Factors to the WECC regional differences as are assigned to NERC Requirements R2.4 and R2.5 in FAC-010-1 and Requirement R3.3 for FAC-011-1. The Commission believes that WECC's approach is reasonable and approves of that proposal. Should the NERC process arrive at a different conclusion, WECC and NERC must justify any disparate treatment in their filing of WECC Violation Risk Factors. To accommodate the WECC process and, in light of the fact that the NERC Violation Risk Factors will also apply until WECC develops its own, we direct WECC to file Violation Risk Factors for the FAC-010-1 and FAC-011-1 no later than the effective date of the applicable Reliability Standard. The Commission will address issues related to the development of Violation Risk Factors for the WECC regional differences after they have been filed for approval. Similarly, WECC should file Violation Severity Levels at the same time it files Violation Risk Factors. 2. Requirements R2 and R2.1-R2.2.3 for FAC-010-1 and FAC-011-1 147. The NOPR proposed to direct NERC to modify the lower Violation Risk Factor assigned to FAC-010-1, Requirement R2 and the medium Violation Risk Factor assigned to sub-Requirements R2.1-R2.2.3 based on guideline 4, which assesses whether a Violation Risk Factor conforms to NERC's definition for the assigned risk level. The Commission proposed to require NERC to assign each of these requirements a high Violation Risk Factor. 148. FAC-010-1, Requirement R2 requires each planning authority's SOL methodology to include a requirement that SOLs provide for bulk electric system performance consistent with a stable pre-contingency (sub-Requirement R2.1) and post-contingency (sub-Requirements R2.2-R2.2.3) bulk electric system using an accurate system topology with all facilities operating within their ratings and without post-contingency cascading outages or uncontrolled separation. 149. Requirement R2.1 of FAC-010-1 requires each planning authority's SOL methodology to include a requirement that SOLs developed must provide for bulk electric system performance consistent with transient, dynamic and voltage stability in a pre-contingency state and with all facilities in service. In the NOPR, the Commission stated that it believes that a lower Violation Risk Factor is inappropriate because Requirement R2.1 of FAC-010-1 is not administrative in nature. The Commission stated that it believes that a violation of Requirement R2.1 could directly cause or contribute to Bulk-Power System instability, separation or cascading failures, because a violation of Requirement R2.1 means that the system is in an unreliable state even before the system is subject to a contingency. Therefore, we proposed to require NERC to change the Violation Risk Factor for Requirement R.2.1 to high. 150. The Commission had similar concerns with respect to FAC-010-1, Requirement R2.2 because it specifically states that, with regard to post-contingency bulk electric system performance, “[c]ascading outages or uncontrolled separation shall not occur.” Therefore, the Commission reasoned that if Requirement R2.2 is violated for any one of the specific contingencies as described in Requirements R2.2.1-R2.2.3, cascading outages or uncontrolled separation of the Bulk-Power System may occur, which would merit a high Violation Risk Factor. 84 84 NOPR at P 53. 151. The Commission had similar concerns with the Violation Risk Factor assignments of Requirement R2 and sub-Requirements R2.1-2.2.3 of FAC-011-1, which contain language similar to Requirements in FAC-010-1. Consequently, the NOPR proposed to modify the Violation Risk Factors for these Requirements and sub-Requirements to high. Comments 152. NERC disagrees that it should assign high Violation Risk Factors for Requirements R2 and R2.1-R2.2.3 for FAC-010-1. NERC agrees that the lower Violation Risk Factor assignment for Requirement R2 of FAC-010-1 merits reconsideration but does not agree that the Violation Risk Factor assignment for Requirement R2 or the sub-Requirements should be changed from medium to high. NERC proposes to process this proposed change through the Commission-approved Reliability Standards development process. 153. NERC believes that FAC-010-1, Requirement R2 and its subparts should only have a single Violation Risk Factor and this should be medium. NERC maintains that Requirement R2 does not include any obligations to conduct analyses or assessments, but merely lists topics that must be included in the SOL methodology. NERC states that the requirements to follow the methodology in setting the SOLs are included in FAC-014-1. According to NERC, if FAC-010-1 Requirement R2 were violated, the Bulk-Power System would not experience instability, separation, or cascading failures in real-time. All of the uses of the SOLs developed with the methodology in FAC-010-1 are for planning purposes. While failure to comply with Requirement R2 and its sub-requirements over the long term may affect the ability to effectively monitor, control, or restore the Bulk-Power System, NERC states that a violation of theses requirements is unlikely to lead to Bulk-Power System instability, separation, or cascading failures. 154. Ameren argues that, because the FAC Reliability Standards at issue in this proceeding are administrative in nature and are not operational Reliability Standards, a high Violation Risk Factor is inappropriate. Because the Reliability Standards establish methodologies, a violation does not directly threaten reliability. 155. In response to the Commission's proposal in the NOPR, NERC agrees that FAC-011-1, Requirement R2 and its sub-requirements merit consideration for a high Violation Risk Factor assignment. NERC proposes to process this proposed change through its Reliability Standards development process. According to NERC, if the methodology for setting real-time limits is not correct, then the resultant real-time limits may be incorrect and operating to these incorrect limits could directly lead to Bulk-Power System instability, separation, or cascading failures. 156. For the reasons discussed in the general issues section, above, Progress Energy disagrees that the Violation Risk Factors should be modified. Ameren asserts that the Commission approved lower and medium Violation Risk Factors for Requirements in FAC-008-1 and FAC-009-1, which deal with setting and communicating the methodologies for facility ratings and are comparable to FAC-010-1 and FAC-011-1, in the Violation Risk Factor Order. To be consistent with other approved Violation Risk Factors, Ameren argues that the Commission should not order changes to the Violation Risk Factors for FAC-010-1 and FAC-011-1. Commission Determination 157. NERC, Progress Energy and Ameren argue that the failure to have a methodology to develop SOLs that is only used in the planning horizon will not cause or contribute to Bulk-Power System instability, separation, or cascading failures in real-time. The Commission disagrees. The SOLs and remedial measures determined during transmission planning ensure Reliable Operation in real-time. As the Commission stated in Order No. 693, transmission planning is a process that involves a number of stages including developing a model of the Bulk-Power System, using this model to assess the performance of the system for a range of operating conditions and contingencies, determining those operating conditions and contingencies that have an undesirable reliability impact, identifying the nature of potential options and the need to develop and evaluate a range of solutions, and selecting the preferred solution, taking into account the time needed to place the solution in service. 85 Also, the Blackout Report cited FirstEnergy for violation of the then-effective NERC Planning Standard 1A, Category C.3—the equivalent of FAC-10-1, sub-Requirement R2.3.3. 86 The Blackout Report also found that had FirstEnergy conducted adequate planning studies on voltage stability ( *e.g.* , FAC-010-1, Requirement R2.2), it would not have set its minimum acceptable voltage at 90 percent. 87 85 *See* Order No. 693 at P 1683. 86 Blackout Report at 41. 87 *Id* . at 42. 158. Because the SOLs and remedial measures determined during transmission planning ensure Reliable Operation in real-time, the Commission believes that violations of planning requirements of the SOL methodology Reliability Standards present the same potential reliability risks as violations in the operating time horizon. Our determination is consistent with the NERC proposed, and Commission approved definition of a high Violation Risk Factor, which considers the violation of Requirements relevant to the planning time horizon. 159. With regard to FAC-010-1, Requirement R2, and FAC-011-1, Requirement R2, the Commission agrees with NERC that Requirement R2, without its sub-Requirements, includes no required performance or outcome. As such, no Violation Risk Factor needs to be assigned to Requirement R2 in either FAC-010-1 or FAC-011-1. Further, the Commission agrees with NERC that FAC-010-1, sub-Requirements R2.2.1- R2.2.3 are topics to be included in an SOL methodology which do not require an assessment or analysis to be performed. As such, a medium Violation Risk Factor is appropriate. 160. However, with regard to FAC-010-1, sub-Requirements R2.1 and R2.2, the Commission disagrees with NERC that a medium Violation Risk Factor is appropriate. Sub-Requirements R2.1-R2.2 require that the planning authority's SOL methodology must include Requirements for SOLs to demonstrate transient, dynamic, and voltage stability performance pre- and post-contingency. 161. The Commission believes that violations of FAC-010-1, sub-Requirements R2.1 and R2.2 present similar, if not the same, risk to Bulk-Power System reliability as violations of TPL-001-0, Requirement R1 and TPL-002-0, Requirement R1. TPL-001-0, Requirement R1 establishes reliable pre-contingency Bulk-Power System performance. NERC proposed, and the Commission approved, a high Violation Risk Factor for TPL-001-0, Requirement R1. TPL-002-0, Requirement R1 establishes reliable post-contingency Bulk-Power System performance. The Commission directed, and NERC revised, the Violation Risk Factor assignment for TPL-002-0, Requirement R1 to high to be consistent with the pre-contingency performance Requirement of TPL-001-0, Requirement R1. The Commission believes both TPL Requirements establish similar, if not the same, Bulk-Power System performance metrics as FAC-010-1, Requirements R2.1 and R2.2. 162. Further, contrary to NERC's position, the Commission believes that to demonstrate the pre- and post-contingency performance metrics required by Requirements R2.1-R2.2 an assessment or analysis would need to be performed. As such, Requirements R2.1-R2.2 provide for actions that go beyond NERC's characterization of the subject of the requirements as limited to a list of topics that must be included in a methodology. Therefore, we conclude that these Requirements are more properly treated as implementation or operational requirements that may have a direct impact on reliability. 163. For the same reasons, the Commission does not agree with Ameren's argument that the Commission's proposal is inconsistent with prior Violation Risk Factor determinations made for what Ameren believes to be comparable Requirements of Reliability Standards FAC-008-1 and FAC-009-1. 88 As examples in support of its argument, Ameren points to the Commission approved medium Violation Risk Factors for FAC-008-1, Requirements R1.3.1-R1.3 and the lower Violation Risk Factors for the remaining Requirements, all of which establish topics that do not incorporate a performance metric to be included in a methodology. Ameren also points to the medium Violation Risk Factor assignments for Requirements of FAC-009-1 that establish facility ratings based on a methodology. As the Commission states previously in this order, FAC-010-1 and FAC-011-1 do not merely establish documentation, methodologies, and administrative tasks, as is the case for the Requirements that Ameren points to as examples of inconsistencies. The FAC-010-1 and FAC-011-1 Requirements at issue require the Bulk-Power System to demonstrate transient, dynamic, and voltage stability performance pre- and post-contingency. The Commission believes that, to demonstrate the pre- and post-contingency performance metrics required by these Requirements, an assessment or analysis would need to be performed. The Commission approved high Violation Risk Factors for similar Bulk-Power System performance metrics. As such, the Requirements at issue go beyond the establishment and documentation of a methodology as Ameren suggests and are fully consistent with the Violation Risk Factor assignments the Commission has previously approved. 88 Ameren Comments at 14-15. 164. The Commission agrees with NERC that the Requirements to follow a methodology when determining SOLs are included in FAC-014-1. However, as the Commission states above, FAC-010-1, Requirements R2.1-R2.2 establish the performance metrics of the SOL methodology used. Thus, if the planning authority's methodology to develop SOLs does not meet the demonstrated performance metrics of these Requirements in a planning time horizon, then under emergency, abnormal, or restorative conditions, the Bulk-Power System would be at risk of instability, separation, or cascading failures. 165. With regard to the determination of SOLs for the operations time horizon established by Reliability Standard FAC-011-1, Requirement 2 and its sub-Requirements, NERC comments, “if the methodology for setting real-time limits is not correct, then the resultant real-time limits may be incorrect and operating to these incorrect limits could directly lead to bulk-power system instability, separation, or cascading failures.” 89 As such, NERC's statement supports the Commission's rationale that FAC-011-1, Requirements R2.1-R2.2.3 merit consideration of a high Violation Risk Factor. Consistent with the previous Commission determination in this order that time horizons are irrelevant in the determination of an appropriate Violation Risk Factor assignment, and to ensure consistency with the conclusions of the Blackout Report (guideline 1) and among similar Requirements of Reliability Standards (guideline 3), the Commission directs NERC to revise the Violation Risk Factor assigned to FAC-010-1, Requirements R2.1-R2.2 to high. 89 NERC Comments at 39. 166. Similar to FAC-010-1, Requirements R2.2.1-R2.2.3, the Commission believes that FAC-011-1, Requirements R2.2.1-R2.2.3 describe topics to be included in an SOL methodology and do not require an assessment or analysis to be performed. Therefore, the Commission believes a medium Violation Risk Factor is appropriate for these Requirements. Consequently, the Violation Risk Factor assignments for FAC-011-1, Requirements R2.2.1-R2.2.3 do not need to be revised as the Commission proposed in the NOPR. 3. FAC-014-1, Requirement R5 167. In the NOPR, the Commission proposed to require NERC to assign a high Violation Risk Factor to FAC-014-1, Requirement R5 and sub-Requirements R5.1-5.1.4. The Commission was concerned that NERC's proposal was not consistent with the findings of the Blackout Report. 168. Requirement R5 requires that the reliability coordinator, planning authority and transmission planner each provide its SOLs and IROLs to those entities that have a reliability-related need for those limits and provide a written request that includes a schedule for delivery of those limits. Sub-Requirements R5.1-R5.1.4 comprise the list of supporting information to be provided. 169. The Blackout Report identified ineffective communications as one common factor of the August 2003 blackout and other previous major blackouts 90 and explained that, “[u]nder normal conditions, parties with reliability responsibility need to communicate important and prioritized information to each other in a timely way, to help preserve the integrity of the grid.” 91 Because the Blackout Report, as well as reports on other previous major blackouts, determined that the timely communication of important and prioritized information, in this case, SOLs and IROLs, to entities that have a reliability-related need for those limits are crucial in maintaining the reliability of the Bulk-Power System, the Commission stated that it believed assigning a medium Violation Risk Factor assignment to FAC-014-1, Requirement R5 and sub-Requirements R5.1-5.1.4 was not consistent with the findings of the Blackout Report. The Commission, therefore, proposed to require NERC to assign a high Violation Risk Factor to these Requirements. 90 Blackout Report at 107. 91 *Id* . at 109. Comments 170. NERC does not agree with the Commission's proposed modification to FAC-014-1, Requirement R5 and its subparts. NERC maintains that, while failure to act to prevent and/or mitigate an instance of exceeding an IROL is expected to result in adverse system consequences, FAC-014-1, Requirement R5 is not aimed at preventing and/or mitigating an IROL. Rather, according to NERC, FAC-014-1, Requirement R5 is aimed at communicating information to others. NERC agrees that effective communication is one factor that can contribute to Bulk-Power System instability, separation, or cascading failures, meriting a medium Violation Risk Factor. 171. However, NERC does not agree that the failure to communicate the actual or potential existence of SOLs and IROLs to those entities that are not required to resolve those limits will result in Bulk-Power System instability, separation, or cascading. NERC maintains that the impact of not notifying adjacent entities of an actual or potential IROL is a medium risk as it only impacts the ability of neighboring entities to effectively monitor the Bulk-Power System. Further, NERC notes that IRO-015-1, Requirement R1 requires that the reliability coordinator make notifications and exchange reliability-related information with other reliability coordinators. This requirement was approved by the Commission with the medium Violation Risk Factor assignment. This FAC-014-1, Requirement R5 is of a similar nature to IRO-015-1, Requirement R1 and should therefore maintain its medium Violation Risk Factor assignment. 172. For the same reasons discussed above, Progress Energy argues that the Commission should not modify the Violation Risk Factor to high. Ameren asserts that the Commission approved medium Violation Risk Factors for Requirements in FAC-013-1, which sets procedures for establishing and communicating transfer capabilities and is comparable to FAC-014-1, in the *Violation Risk Factor Order* . To be consistent with other approved Violation Risk Factors, Ameren argues that the Commission should not order changes to the Violation Risk Factors for FAC-014-1. Commission Determination 173. The Commission agrees with NERC that FAC-014-1, Requirement R5 is not aimed at the prevention and/or mitigation of IROLs, but rather the communication of SOL and IROL information. However, NERC's argument is flawed in that Requirement R5 requires reliability coordinators, planning authorities and transmission planners to communicate and provide SOL and IROL information to entities that have a reliability-related need for those limits. NERC's comments, on the other hand, focus on provision of information to entities that are not required to resolve those limits. Therefore, a failure to notify adjacent entities of an actual or potential IROL creates a demonstrable risk because it impairs the ability of neighboring entities to effectively monitor the Bulk-Power System. In addition, the Commission believes that this Requirement applies to both real-time operations and the planning time frames, by ensuring that inter-dependent IROLs in adjacent footprints are duly considered in the planning time frame and timely remedial actions are taken in real-time operation. 174. In the *Violation Risk Factor Order* , the Commission applied guideline 1 to ensure critical areas identified as causes of that and other previous major blackouts are appropriately assigned Violation Risk Factors. Ineffective communication was identified as a factor common to the August 2003 blackout and other previous major blackouts. 92 Further, the Blackout Report stated that “[i]neffective communications contributed to a lack of situational awareness and precluded effective actions to prevent the cascade.” 93 92 *Id.* at 109. 93 *Id.* at 161. 175. For the reasons stated above and lessons learned from previous blackouts, the Commission believes Violation Risk Factor for Requirement R5 and the sub-requirements in R5.1 should be assigned as high to reflect the potential reliability risk of not communicating IROLs to adjacent entities that have a reliability-related need for the information. Since SOLs are determined to maintain Bulk-Power System facilities within acceptable operating limits, the communication of those limits to those with a reliability related need, ensures the protection of Bulk-Power System facilities, thus preventing cascading failures of the interconnected grid, the Commission directs NERC to assign a high Violation Risk Factor to FAC-014-1, Requirement R5 and sub-Requirements R5.1. 176. The Commission also disagrees with NERC that the Commission's proposal to revise Violation Risk Factors for Requirement R5 and its sub-Requirements is inconsistent with previously approved Violation Risk Factor assignments. NERC's reference to the medium Violation Risk Factor assigned to IRO-015-1, Requirement R1 and Ameren's reference to the medium Violation Risk Factor assigned to FAC-013-1 Requirements are not inconsistencies. In both instances, the information that is to be provided is not specifically relevant to SOLs and IROLs, where the Commission has approved high Violation Risk Factors. For example, the high Violation Risk Factor the Commission proposed in the NOPR is consistent with previously approved Violation Risk Factor assignments for similar Requirements R4 and R5 of Reliability Standard IRO-004-1. Reliability Standard IRO-004-1, Requirements R4 and R5 establish the provision and sharing of system study information, respectively, relevant to the determination of SOLs and IROLs. NERC proposed, and the Commission approved a high Violation Risk Factor for IRO-004-1, Requirements R4 and R5. As such, to ensure consistency with the conclusions of the Blackout Report and among similar Requirements of other Reliability Standards, the Commission directs NERC to revise the Violation Risk Factors for FAC-014-1, Requirements R5 and R5.1 to high. 177. The Commission believes, however, that FAC-014-1, Requirements R5.1.1—R5.1.4 provide supporting information. Therefore, the Commission believes a medium Violation Risk Factor is appropriate for these Requirements and the Violation Risk Factor assignments for FAC-014-1, Requirements R5.1.1-R5.1.4 do not need to be revised as the Commission proposed in the NOPR. 4. FAC-010-1, Requirement 3.6 178. Reliability Standard FAC-010-1, Requirement 3.6 establishes the criteria for determining, in the planning time horizon, when violating an SOL qualifies as an IROL, and criteria for developing any associated IROL T <sup>v.</sup> NERC proposed to assign Requirement 3.6 a lower Violation Risk Factor. However, NERC proposed a medium Violation Risk Factor assignment to Reliability Standard FAC-011-1, Requirement R3.7 which establishes the same criteria in the operating time horizon. The Commission believes that the criteria for determining when violating an SOL qualifies as an IROL should be the same regardless of whether in the planning time horizon or the operating time horizon. This fact is supported by the Blackout Report finding that FirstEnergy did not have an adequate criterion to determine voltage stability in both the planning and operating time frames. That failure led to the company in adopting an inappropriate 90 percent minimum acceptable voltage factor. 94 Based on these facts, the Commission concludes that the potential reliability risk to the Bulk-Power system for a violation of those criteria in the planning horizon is the same as the potential reliability risk in the operating horizon. The Commission expects consistency between similar, and in this instance, identically-worded, Requirements of Reliability Standards. Therefore, the Commission directs NERC to ensure that the proposed Violation Risk Factor for FAC-010-1, Requirement R3.6 is changed from lower to medium. 94 Blackout Report at 42. 5. FAC-011-1, Requirement 3.4 179. NERC did not propose a Violation Risk Factor assignment for Reliability Standard FAC-011-1, Requirement R3.4. Requirement R3.4 establishes a requirement that a Reliability Coordinator's SOL methodology include a description of the level of detail to be reflected in the system models that are used in the operating time frame. NERC assigned a lower Violation Risk Factor to FAC-010-1, Requirement 3.3 which establishes the same requirement for Planning Authorities' SOL methodologies in the planning time frame. Consistent with the definition of a lower Violation Risk Factor, the Commission believes that a violation of FAC-011-1, Requirement 3.4 would not be expected to affect the electrical state or capability or the Bulk-Power System or the ability to effectively monitor and control the Bulk-Power System. As such, and to ensure consistency among similar Requirements of Reliability Standards, the Commission believes a lower Violation Risk Factor assignment is appropriate for FAC-011-1, Requirement R3.4. IV. Information Collection Statement 180. The Office of Management and Budget
(OMB)regulations require that OMB approve certain reporting and recordkeeping (collections of information) imposed by an agency. 95 The information collection requirements in this Final Rule are identified under the Commission data collection, FERC-725D “Facilities Design, Connections and Maintenance Reliability Standards.” Under section 3507(d) of the Paperwork Reduction Act of 1995, 96 the proposed reporting requirements in the subject rulemaking will be submitted to OMB for review. Interested persons may obtain information on the reporting requirements by contacting the Federal Energy Regulatory Commission, 888 First Street, NE., Washington, DC. 20426 [Attention: Michael Miller, Office of the Chief Information Officer], *phone:*
(202)502-8415, *fax:*
(202)208-2425, *e-mail:* *Michael.Miller@ferc.gov.* Comments on the requirements of the proposed rule may be sent to the Office of Information and Regulatory Affairs, Office of Management and Budget, Washington, DC 20503 [Attention: Desk Officer for the Federal Energy Regulatory Commission], *fax:* 202-395-7285, *e-mail: oira_submission@omb.eop.gov* . 95 5 CFR 1320.11 (2007). 96 44 U.S.C. 3507(d). 181. The “public protection” provisions of the Paperwork Reduction Act of 1995 requires each agency to display a currently valid control number and inform respondents that a response is not required unless the information collection displays a valid OMB control number on each information collection or provides a justification as to why the information collection number cannot be displayed. In the case of information collections published in regulations, the control number is to be published in the **Federal Register** . 182. The NOPR proposed to approve three new Reliability Standards developed by NERC as the ERO. The NOPR stated that the three proposed Reliability Standards do not require responsible entities to file information with the Commission. Nor, with the exception of a three year self-certification of compliance, do the Reliability Standards require responsible entities to file information with the ERO or Regional Entities. However, the Reliability Standards do require responsible entities to develop and maintain certain information for a specified period of time, subject to inspection by the ERO or Regional Entities. 97 97 *See* NOPR at P 60-61 for a description of this information. 183. *Burden Estimate:* Our estimate below regarding the number of respondents is based on the NERC compliance registry as of April 2007. NERC and the Regional Entities have identified approximately 170 Investor-Owned Utilities, and 80 Large Municipals and Cooperatives. NERC's compliance registry indicates that there is a significant amount of overlap among the entities that perform these functions. In some instances, a single entity may be registered under all four of these functions. Thus, the Commission estimates that the total number of entities required to comply with the information “reporting” or development requirements of the proposed Reliability Standards is approximately 250 entities. About two-thirds of these entities are investor-owned utilities and one-third is a combination of municipal and cooperative organizations. 184. The Public Reporting burden for the requirements approved in the Final Rule is as follows: Data collection FERC-725D Number of respondents Number of responses Hours per respondent Total annual hours Investor-Owned Utilities 170 1 Reporting: 90 Reporting: 15,300. Recordkeeping: 210 Recordkeeping: 35,700. Large Municipals and Cooperatives 80 1 Reporting: 90 Reporting: 7,200. Recordkeeping: 210 Recordkeeping: 16,800. Total 250 75,000. *Total Hours:* (Reporting 22,500 hours + Recordkeeping 52,500 hours) = 75,000 hours. ( *FTE=Full Time Equivalent or 2,080 hours* ). *Total Annual Hours for Collection: (Reporting + Recordkeeping* = 75,000 hours. *Information Collection Costs:* The Commission projects the average annualized cost to be the total annual hours (reporting) 22,500 times $120 = $2,700,000. Recordkeeping = 52,500 @ $40/hour = $2,100,000. Labor (file/record clerk @ $17 an hour + supervisory @ $23 an hour). Storage 1,800 sq. ft. × $925 (off site storage) = $1,665,000. Total costs = $6,465,000. The Commission believes that this estimate may be conservative because most if not all of the applicable entities currently perform SOL calculations and the proposed Reliability Standards will provide a common methodology for those calculations. *Title:* FERC-725D Facilities Design, Connections and Maintenance Reliability Standards. *Action:* Proposed Collection of Information. *OMB Control No.:* 1902-0247. *Respondents:* Business or other for profit, and/or not for profit institutions. *Frequency of Responses:* One time to initially comply with the rule, and then on occasion as needed to revise or modify. In addition, annual and three-year self-certification requirements will apply. *Necessity of the Information:* The three Reliability Standards, if adopted, would implement the Congressional mandate of the Energy Policy Act of 2005 to develop mandatory and enforceable Reliability Standards to better ensure the reliability of the nation's Bulk-Power System. Specifically, the three proposed Reliability Standards would ensure that system operating limits or SOLs used in the reliability planning and operation of the Bulk-Power System are determined based on an established methodology. *Internal review:* The Commission has reviewed the requirements pertaining to mandatory Reliability Standards for the Bulk-Power System and determined the proposed requirements are necessary to meet the statutory provisions of the Energy Policy Act of 2005. These requirements conform to the Commission's plan for efficient information collection, communication and management within the energy industry. The Commission has assured itself, by means of internal review, that there is specific, objective support for the burden estimates associated with the information requirements. V. Environmental Analysis 185. The Commission is required to prepare an Environmental Assessment or an Environmental Impact Statement for any action that may have a significant adverse effect on the human environment. 98 The Commission has categorically excluded certain actions from this requirement as not having a significant effect on the human environment. The actions proposed here fall within the categorical exclusion in the Commission's regulations for rules that are clarifying, corrective or procedural, for information gathering, analysis, and dissemination. 99 Accordingly, neither an environmental impact statement nor environmental assessment is required. 98 Order No. 486, *Regulations Implementing the National Environmental Policy Act* , 52 FR 47897 (Dec. 17, 1987), FERC Stats. & Regs., Regulations Preambles 1986-1990 ¶ 30,783 (1987). 99 18 CFR 380.4(a)(5) (2007). VI. Regulatory Flexibility Act Certification 186. The Regulatory Flexibility Act of 1980
(RFA)100 generally requires a description and analysis of final rules that will have significant economic impact on a substantial number of small entities. Most of the entities, *i.e.* , planning authorities, reliability coordinators, transmission planners and transmission operators, to which the requirements of this Final Rule apply do not fall within the definition of small entities. 101 100 5 U.S.C. 601-612. 101 The RFA definition of “small entity” refers to the definition provided in the Small Business Act (SBA), which defines a “small business concern” as a business that is independently owned and operated and that is not dominant in its field of operation. *See* 15 U.S.C. 632. According to the SBA, a small electric utility is defined as one that has a total electric output of less than four million MWh in the preceding year. 187. As indicated above, based on available information regarding NERC's compliance registry, approximately 250 entities will be responsible for compliance with the three new Reliability Standards. It is estimated that one-third of the responsible entities, about 80 entities, would be municipal and cooperative organizations. The approved Reliability Standards would apply to planning authorities, transmission planners, transmission operators and reliability coordinators, which tend to be larger entities. Thus, the Commission believes that only a portion, approximately 30 to 40 of the municipal and cooperative organizations to which the approved Reliability Standards will apply, qualify as small entities. 102 The Commission does not consider this a substantial number. Moreover, as discussed above, the approved Reliability Standards will not be a burden on the industry since most if not all of the applicable entities currently perform SOL calculations and the approved Reliability Standards will simply provide a common methodology for those calculations. Accordingly, the Commission certifies that the approved Reliability Standards will not have a significant adverse impact on a substantial number of small entities. 102 According to the Department of Energy's
(DOE)Energy Information Administration (EIA), there were 3,284 electric utility companies in the United States in 2005, and 3,029 of these electric utilities qualify as small entities under the SBA definition. Among these 3,284 electric utility companies are:
(1)883 cooperatives of which 852 are small entity cooperatives;
(2)1,862 municipal utilities, of which 1,842 are small entity municipal utilities;
(3)127 political subdivisions, of which 114 are small entity political subdivisions; and
(4)219 privately owned utilities, of which 104 could be considered small entity private utilities. *See* Energy Information Administration Database, Form EIA-861, DOE (2005), *available at http://www.eia.doe.gov/cneaf/electricity/page/eia861.html* . 188. Based on this understanding, the Commission certifies that this rule will not have a significant economic impact on a substantial number of small entities. Accordingly, no regulatory flexibility analysis is required. VII. Document Availability 189. In addition to publishing the full text of this document in the **Federal Register** , the Commission provides all interested persons an opportunity to view and/or print the contents of this document via the Internet through FERC's Home Page ( *http://www.ferc.gov* ) and in FERC's Public Reference Room during normal business hours (8:30 a.m. to 5 p.m. Eastern time) at 888 First Street, NE., Room 2A, Washington DC 20426. 190. From FERC's Home Page on the Internet, this information is available on eLibrary. The full text of this document is available on eLibrary in PDF and Microsoft Word format for viewing, printing, and/or downloading. To access this document in eLibrary, type the docket number excluding the last three digits of this document in the docket number field. 191. User assistance is available for eLibrary and the FERC's Web site during normal business hours from FERC's Online Support at 202-502-6652 (toll free at 1-866-208-3676) or e-mail at *ferconlinesupport@ferc.gov* , or the Public Reference Room at
(202)502-8371, TTY
(202)502-8659. E-mail the Public Reference Room at *public.referenceroom@ferc.gov* . VIII. Effective Date and Congressional Notification 192. These regulations are effective February 8, 2008. The Commission has determined, with the concurrence of the Administrator of the Office of Information and Regulatory Affairs of OMB, that this rule is not a “major rule” as defined in section 351 of the Small Business Regulatory Enforcement Fairness Act of 1996. By the Commission. Kimberly D. Bose, Secretary. Appendix A: Commission Directed Revisions to Violation Risk Factor Assignments Standard number Requirement number Text of requirement Violation risk factor NERC proposal Commission determination Guideline FAC-010-1 R2 The Planning Authority's SOL Methodology shall include a requirement that SOLs provide BES performance consistent with the following: Lower Explanatory Text FAC-010-1 R2.1 In the pre-contingency state, the BES shall demonstrate transient, dynamic and voltage stability; all Facilities shall be within their Facility Ratings and within their thermal, voltage and stability limits. In the determination of SOLs, the BES condition used shall reflect current or expected system conditions and shall reflect changes to system topology such as Facility outages Medium High 3 (Consistent with FAC-011-1 R2.1). FAC-010-1 R2.2 Following the single Contingencies 1 identified in Requirement 2.2.1 through Requirement 2.2.3, the system shall demonstrate transient, dynamic and voltage stability; all Facilities shall be operating within their Facility Ratings and within their thermal, voltage and stability limits; and Cascading Outages or uncontrolled separation shall not occur Medium High 3 (Consistent with FAC-011-1 R2.2). FAC-010-1 R3.6 Criteria for determining when violating a SOL qualifies as an Interconnection Reliability Operating Limit
(IROL)and criteria for developing any associated IROL Tv Lower Medium 3 (Consistent with FAC-011-1 R3.7). FAC-011-1 R2* The Reliability Coordinator's SOL Methodology shall include a requirement that SOLs provide BES performance consistent with the following: Medium Explanatory Text FAC-011-1 R2.1* In the pre-contingency state, the BES shall demonstrate transient, dynamic and voltage stability; all Facilities shall be within their Facility Ratings and within their thermal, voltage and stability limits. In the determination of SOLs, the BES condition used shall reflect current or expected system conditions and shall reflect changes to system topology such as Facility outages Medium High FAC-011-1 R2.2* Following the single Contingencies 1 identified in Requirement 2.2.1 through Requirement 2.2.3, the system shall demonstrate transient, dynamic and voltage stability; all Facilities shall be operating within their Facility Ratings and within their thermal, voltage and stability limits; and Cascading Outages or uncontrolled separation shall not occur Medium High FAC-011-1 R3.4 Level of detail of system models used to determine SOLs Not assigned Lower 3 (Consistent with FAC-010-1 R3.3). FAC-014-1 R5 The Reliability Coordinator, Planning Authority and Transmission Planner shall each provide its SOLs and IROLs to those entities that have a reliability-related need for those limits and provide a written request that includes a schedule for delivery of those limits as follows: Medium High 1, 3 (Consistent with IRO-004-1 R4 & R5). FAC-014-1 R5.1 The Reliability Coordinator shall provide its SOLs (including the subset of SOLs that are IROLs) to adjacent Reliability Coordinators and Reliability Coordinators who indicate a reliability-related need for those limits, and to the Transmission Operators, Transmission Planners, Transmission Service Providers and Planning Authorities within its Reliability Coordinator Area. For each IROL, the Reliability Coordinator shall provide the following supporting information: Medium High 1, 3 (Consistent with IRO-004-1 R4 & R5). * Requirements whose proposed Violation Risk Factor assignment NERC identifies as meriting reconsideration. Guideline 1: Violation Risk Factor assignment not consistent with Final Blackout Report conclusions. Guideline 3: Violation Risk Factor assignment not consistent among Reliability Standards with similar Reliability Requirements. Appendix B: Commenters on Notice of Proposed Rulemaking Abbreviation Entity Ameren Ameren Service Co. APPA American Public Power Association BPA + Bonneville Power Administration Duke Duke Energy Corporation EEI Edison Electric Institute EPSA Electric Power Supply Association FirstEnergy + FirstEnergy Service Company IESO Independent Electricity System Operator of Ontario ISO/RTO Council ISO/RTO Council MidAmerican MidAmerican Energy Company and PacifiCorp Midwest ISO Midwest Independent Transmission System Operator, Inc. NERC North American Electric Reliability Corp. NYISO + New York Independent System Operator, Inc. NRECA National Rural Electric Cooperative Association NYSRC New York State Reliability Council, LLC Ontario IESO + Ontario Independent Electricity System Operator Progress Energy Progress Energy, Inc. Santa Clara City of Santa Clara, California, doing business as Silicon Valley Power SoCal Edison Southern California Edison Company Southern Southern Company Services, Inc. WECC Western Electricity Coordinating Council Xcel Xcel Energy Services + Comments filed out-of-time. BILLING CODE 6717-01-P ER09JA08.015 ER09JA08.016 ER09JA08.017 ER09JA08.018 ER09JA08.019 ER09JA08.020 ER09JA08.021 ER09JA08.022 ER09JA08.023 ER09JA08.024 ER09JA08.025 ER09JA08.026 ER09JA08.027 ER09JA08.028 ER09JA08.029 ER09JA08.030 ER09JA08.031 ER09JA08.032 [FR Doc. E7-25488 Filed 1-8-08; 8:45 am] BILLING CODE 6717-01-C 73 6 Wednesday, January 9, 2008 Presidential Documents Part V The President Memorandum of December 27, 2007—Provision of Aviation Insurance Coverage for Commercial Air Carrier Service in Domestic and International Operations Title 3— The President Memorandum of December 27, 2007 Provision of Aviation Insurance Coverage for Commercial Air Carrier Service in Domestic and International Operations Memorandum for the Secretary of Transportation By the authority vested in me as President by the Constitution and laws of the United States including 49 U.S.C. 44302, *et seq* ., I hereby: 1. Determine that continuation of U.S.-flag commercial air service is necessary in the interest of air commerce, national security, and the foreign policy of the United States. 2. Approve provision by the Secretary of Transportation (Secretary) of insurance or reinsurance to U.S.-flag air carriers against loss or damage arising out of any risk from the operation of an aircraft in the manner and to the extent provided in chapter 443 of 49 U.S.C.:
(a)until August 31, 2008;
(b)after August 31, 2008, but no later than December 31, 2008, when the Secretary determines that such insurance or reinsurance cannot be obtained on reasonable terms and conditions from any company authorized to conduct an insurance business in a State of the United States; and 3. Delegate to the Secretary the authority, vested in me by 49 U.S.C. 44306(c), to extend this determination for additional periods beyond August 31, 2008, but no later than December 31, 2008, when the Secretary finds that the continued operation of aircraft to be insured or reinsured is necessary in the interest of air commerce or the national security, or to carry out the foreign policy of the United States Government. You are directed to bring this determination immediately to the attention of all air carriers within the meaning of 49 U.S.C. 40102(2), and to arrange for its publication in the **Federal Register** . GWBOLD.EPS THE WHITE HOUSE, Washington, December 27, 2007. [FR Doc. 08-75 Filed 1-8-08; 11:15 am]
Connectionstraces to 77
Traces to 77 documents
U.S. Code
- Registration, responsibilities, and oversight of self-regulatory organizations§ 78s
- National securities exchanges§ 78f
- Public information; agency rules, opinions, orders, records, and proceedings§ 552
- Definitions and application§ 78c
- Records maintained on individuals§ 552a
- Citizen of the United States§ 911
- Travel control of citizens and aliens§ 1185
- Powers, authorities, and duties of United States Secret Service§ 3056
- Responsibility of Secretary of State§ 4802
- Expenses of detection of underpayments and fraud, etc.§ 7623
- Departmental regulations§ 301
- Confidentiality and disclosure of returns and return information§ 6103
- Other applicable rules§ 7852
- Federal agency responsibilities§ 3506
- Public information collection activities; submission to Director; approval and delegation§ 3507
- Requirements for certain mortgages§ 1639
- Disclosure guidelines§ 1604
- Definitions and rules of construction§ 1602
- Unfair methods of competition unlawful; prevention by Commission§ 45
- Exempted transactions§ 1603
- Prohibition against kickbacks and unearned fees§ 2607
- Effect on other laws§ 1610
- Congressional findings and declaration of purpose§ 1601
- Declaration of policy§ 3601
- Advertising of open end consumer credit plans secured by consumer’s principal dwelling§ 1665b
- Disclosure requirements for open end consumer credit plans secured by consumer’s principal dwelling§ 1637a
- Advertising of credit other than open end plans§ 1664
- Form of disclosure; additional information§ 1632
- Transactions other than under an open end credit plan§ 1638
- Civil liability§ 1640
- Liability of assignees§ 1641
- Repealed. Pub. L. 96–221, title VI, § 614(e)(1), Mar. 31, 1980, 94 Stat. 180§ 1636
- Administrative enforcement§ 1607
- Adjustable rate mortgage caps§ 3806
- Congressional findings and purpose§ 2601
- Definitions§ 2602
- Purposes§ 3501
- Recordkeeping, inspections, monitoring, and entry§ 7414
- Establishment, functions, and activities§ 272
- SHORT TITLE.§ 801
- EXPEDITED PROCESSING OF REQUESTS FOR JAPANESE IMPERIAL GOVERNMENT RECORDS.§ 804
- Congressional findings and declaration of purpose§ 7401
- Electric reliability§ 824o
- Definitions§ 632
- General authority§ 44302
- Premiums and limitations on coverage and claims§ 44306
- Definitions§ 40102
CFR
- Delegation of authority to Director of Division of Trading and Markets.§ 200.30-3
- Denial of Public Access to Confidential Financial Disclosure Reports---OGE Form 450.§ 171.32
- Does FAA invite public comment on petitions for exemption?§ 11.85
- Pilot logbooks.§ 61.51
- Requirements for certain closed-end home mortgages.§ 226.32
- Late charges.§ 444.4
- Payments.§ 226.10
- Advertising.§ 213.7
- Advertising.§ 226.16
- Advertising.§ 226.24
- General disclosure requirements.§ 226.17
- Right of rescission.§ 226.23
- Record retention.§ 226.25
- Prohibited acts or practices in connection with higher-priced mortgage loans.§ 226.35
- Rules concerning requests for information.§ 202.5
- Hazard communication.§ 1910.1200
- Ventilation.§ 1910.94
- What size standards has SBA identified by North American Industry Classification System codes?§ 121.201
- Definitions.§ 63.2
- Reliability Standards.§ 39.5
- Projects or actions categorically excluded.§ 380.4
register
38 references not yet in our index
- 17 CFR 240.19
- 8 USC 1401-1503
- 22 USC 211a-218
- 22 CFR 171
- 22 CFR 171.36(b)(1)
- 5 CFR 1320.8(d)
- IRM 1.16
- IRM 1.15.23
- 31 CFR 1.36
- Pub. L. 104-13
- 44 USC 3501-3521
- 12 CFR 226
- 405 U.S. 233
- 12 CFR 203.4(a)(12)
- 432 F. Supp. 2d 181
- 64 F. Supp. 2d 1156
- 24 CFR 3500.2
- 12 CFR 227.15
- 12 CFR 535.4
- 12 CFR 202
- Pub. L. 109-8
- 119 Stat. 23
- 5 CFR 1320
- 5 USC 601-612
- 24 CFR 3500.17(b)
- 24 CFR 3500.2(b)
- 24 CFR 3500
- 40 CFR 63
- 40 CFR 70
- 40 CFR 2
- 40 CFR 9
- Pub. L. 104-4
- Pub. L. 104-113
- 40 CFR 70.3(a)
- 18 CFR 40
- Pub. L. 109-58
- 119 Stat. 594
- 5 CFR 1320.11
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cites case law
Notices
Notice of petition for exemption received; correction
SCOTUS405 U.S. 233
F. Supp.432 F. Supp. 2d 181
F. Supp.64 F. Supp. 2d 1156
Cites 115 · showing 12Cited by 0 across 0 sources