FTC Red Flags Rule Clarified; Red Flags Enforcement Likely to Begin in 2011

On December 18, 2010, President Obama signed into law the Red Flag Clarification Act of 2010.  The Act will change a single definition in prior law and reduce the scope of the FTC Red Flags Rule, ending a two-year long saga over the scope of its enforcement.

As we have noted in past entries about Red Flags Rule compliance, the FTC has extended the deadline for enforcement of the FTC’s Red Flags Rule several times, most recently through December 31, 2010.  The stated reason for these delays was “to give Congress time to reach a consensus on the types of businesses that should be covered under the Rule.”  An unstated reason was the mounting number of lawsuits by physicians, lawyers, accountants, and other service providers seeking to exempt themselves from the Red Flags Rule.  The lawsuits should now come to an end.

Here’s how the new law will work. The definition of who is considered to be a “creditor” is a key to the application of the Red Flags Rule. As originally drafted, “creditors” would have included anyone “who regularly extends, renews, or continues credit” or “who regularly arranges for the extension, renewal, or continuation of credit,” 15 U.S.C. § 1691a(e); see 15 U.S.C. § 1681a(r)(5). The new Act narrows this definition by excluding anyone who advances funds on behalf of a person for expenses incidental to a service provided by the creditor to that person. Examples of this exclusion would include a doctor who pays upfront for a test that a patient will reimburse him for later, or a lawyer who covers a filing fee for a client until his bill is paid.

With this change, it is likely that the FTC will commence enforcement against the intended targets of the Red Flags Rule – the financial services industry – in 2011.