The New York Department of Financial Services (DFS) issued a press release yesterday to announce that it is leading a multistate investigation into the payroll advance industry.  A payroll advance allows an employee to access wages that he or she has earned before the payroll date on which such wages are to be paid by the employer.  The cost of obtaining a payroll advance can take various forms, such as “tips” or monthly membership fees where an employee works for a company that participates in the payroll advance program.

An increasing number of employers are using payroll advances as an important employee benefit.  Payroll advances can be offered in states that prohibit payday loans and can be less costly than payday loans or overdraft fees on bank checking accounts.  Participants in these programs do not view the advances as “loans” or “credit” or the tips as “interest” or “finance charges.”  Rather, they argue that the advances are payments for compensation already earned.

In its press release, the DFS claims that the investigation will look into “allegations of unlawful online lending” and “will help determine whether these payroll advance practices are usurious and harming consumers.”  According to the DFS, some payroll advance companies “appear to collect usurious or otherwise unlawful interest rates in the guise of “tips,” monthly membership and/or exorbitant additional fees, and may force improper overdraft charges on vulnerable low-income consumers.”  The DFS states that the investigation will focus on “whether companies are in violation of state banking laws, including usury limits, licensing laws and other applicable laws regulating payday lending and consumer protection laws.”  It indicates that it is sending letters to members of the payroll advance industry to request information.

The investigation into the payroll advance industry represents another effort by regulators to broadly define “credit” or “loan” and expand the definition of “interest” in the context of providers of alternative financial products, such as litigation funding companies, merchant cash advance providers, and other finance companies whose products are structured as purchases rather than loans.  Under former Director Cordray’s leadership, the CFPB took action against structured settlement and pension advance companies.  The first CFPB enforcement action under former Acting Director Mulvaney’s leadership was also filed against a pension advance company and alleged that the company made predatory loans to consumers that were falsely marketed as asset purchases.  In January 2019, under Director Kraninger’s leadership and in partnership with two state regulators, the CFPB entered into a consent order with an individual who was alleged to have violated the Consumer Financial Protection Act in connection with his brokering of contracts providing for the assignment of veterans’ pension payments to investors in exchange for lump sum amounts.  The individual’s alleged unlawful conduct included misrepresenting to consumers that the transactions were sales “and not high-interest credit offers.”

The DFS investigation is a reminder of the need for all providers of alternative financial products to carefully analyze product terms and to revisit true sale compliance, both in the language of their agreements and in the company’s actual practices.

The other state regulators identified in the DFS’s press release as joining the investigation are the following:

  1. Connecticut Department of Banking
  2. Illinois Department of Financial Professional Regulation
  3. Maryland Office of the Commissioner for Financial Regulation
  4. New Jersey Department of Banking and Insurance
  5. North Carolina Office of the Commissioner of Banks
  6. North Dakota Department of Financial Institutions
  7. Oklahoma Department of Consumer Credit
  8. Puerto Rico Comisionado de Instituciones Financieras
  9. South Carolina Department of Consumer Affairs
  10. South Dakota Department of Labor and Regulation’s Division of Banking
  11. Texas Office of Consumer Credit Commissioner

It is interesting to note that no federal agencies or state attorneys general are involved in the investigations.

Our Consumer Financial Services Group has counseled several employers and companies that offer these types of programs.  As the now-public multi-state investigation demonstrates, they must be carefully structured to avoid the application of state licensing, credit, and labor laws.