Last July, the OCC announced its decision to accept applications for special purpose national bank (SPNB) charters from fintech companies.  At that time we observed that, while not discussed in the materials released by the OCC, it appeared that a fintech company holding an SPNB charter would be required to be a member of the Federal Reserve System and be subject to oversight as a member bank.  As a Federal Reserve member, an SPNB would have access to the Federal Reserve discount window and other Federal Reserve services.

According to a Reuters article published today, Federal Reserve officials have expressed reservations about allowing such access to fintech companies.  Reuters reports that “many Fed officials fear that these firms lack robust risk-management controls and consumer protections that banks have in place.”  The article quotes the President of the St. Louis Fed as having expressed concern that “fintech will be the source of the next crisis.” The Atlanta Fed President is quoted as having said that “almost none of [the fintech entrepreneurs he has talked to] has risk at the top of what they’re thinking about, and that makes me nervous.”

Despite its reported reservations about the SPNB charter, the Federal Reserve has acknowledged the increasing role played by fintech in shaping financial and banking landscapes and indicated that it is interested in developing policy solutions that would result in greater efficiencies and benefits to all parties.  To that end, the Philadelphia Fed sponsored a conference last November on “Fintech and the New Financial Landscape.”  At the conference, Ballard Spahr partner Scott Pearson was a member of a panel that discussed “The Roles of Alternative Data in Expanding Credit Access and Bank/Fintech Partnership.”

 

 

 

The OCC has filed a motion to dismiss the lawsuit filed in D.C. federal district court in October 2018 by the Conference of State Bank Supervisors (CSBS) to stop the OCC from issuing special purpose national bank (SPNB) charters to fintech companies.

The CSBS had previously filed a lawsuit challenging the OCC’s authority to grant SPNB charters to fintech companies at a time when the OCC had not yet decided whether it would move forward on its charter proposal.  That lawsuit was dismissed for failing to establish an injury in fact necessary for Article III standing and for lacking ripeness for judicial review.  The new lawsuit was filed in response to the OCC’s July 2018 announcement that it would begin accepting applications for SPNB charters from fintech companies.

In its brief, the OCC makes the following principal arguments in favor of dismissal:

  • CSBS cannot have standing to sue until the OCC approves an application for an SPNB charter because only then could a CSBS member suffer an injury in fact.
  • Because the OCC “remains several stages away from actually granting an SPNB Charter” and “has not finalized its decision to issue an SPNB Charter to a particular applicant,” the matter remains both constitutionally and prudentially unripe for judicial review.
  • Because the OCC’s July 2018 announcement was not a final agency action within the meaning of the Administrative Procedure Act, it is not subject to judicial review under the APA’s arbitrary and capricious standard.
  • The OCC’s July 2018 announcement does not represent a preemption determination to which notice and comment procedures apply “because the question of whether granting a proposed national bank will result in the preemption of any particular state consumer financial law is not relevant to the chartering process.”  (According to the OCC, in deciding whether to grant a charter, its focus is on ”the proposed institution’s prospects and whether it will operate in a safe and sound manner.”)
  • The OCC’s rule (12 C.F.R. Section 5.20(e)(1)) interpreting the term “business of banking” in the National Bank Act by reference to three core banking functions—receiving deposits, paying checks, or lending money—represents a reasonable interpretation of such term and supports treating any one of such functions as the required core activity for purposes of the OCC’s chartering authority.  Nothing in the NBA identifies deposit-taking as an indispensable function for a national bank to be engaged in the “business of banking.”

In September 2018, the New York Department of Financial Services (DFS) filed a second in a New York federal district court to block the OCC’s issuance of SPNB charters.  Like the first CSBS lawsuit, the first DFS lawsuit challenging the OCC’s authority to grant SPNB charters was dismissed for failing to establish an injury in fact necessary for Article III standing and for lacking ripeness for judicial review.

]Last month, the OCC submitted a letter to the court indicating that it intends to file a motion to dismiss the DFS lawsuit. The grounds for the motion set forth in the OCC’s letter substantially mirror its arguments for dismissal above in the CSBS lawsuit.  The DFS also submitted a letter to the court in which, in addition to outlining the arguments it would make in opposing an OCC motion to dismiss, it indicated that it intends to file a motion for a preliminary injunction to prevent the OCC from issuing any SPNB charters while the lawsuit is pending.

The next step in the case is likely to be the entry of an order by the court setting a motion schedule.  However, based on a docket entry indicating that a standing order was entered on December 27 requiring the U.S. Attorney’s Office to notify the court immediately upon the restoration of DOJ funding, it appears any further developments will not occur until the partial government shutdown ends.

 

 

The OCC’s decision to issue special purpose national bank (or fintech) charters has sparked renewed litigation.  In this episode, we review the charter’s potential benefits and drawbacks, provide a litigation update and examine its possible impact on charter applicants, and flag issues for potential applicants.  We also look at fintech charter alternatives, including full-service and Utah industrial banks.

To listen and subscribe to the podcast, click here.

 

 

The Conference of State Bank Supervisors (CSBS) has filed a second lawsuit in D.C. federal district court to stop the Office of the Comptroller of the Currency (OCC) from issuing special purpose national bank (SPNB) charters to fintech companies.  A similar lawsuit was filed last month in a New York federal district court by the New York Department of Financial Services.

The CSBS and the DFS had previously filed lawsuits challenging the OCC’s authority to grant SPNB charters to fintech companies at a time when the OCC had not yet decided whether it would move forward on its charter proposal.  Both lawsuits were dismissed for failing to establish an injury in fact necessary for Article III standing and for lacking ripeness for judicial review.  The new lawsuits were filed in response to the OCC’s July 2018 announcement that it would begin accepting applications for SPNB charters from fintech companies.  In its complaint, the CSBS alleges that “things have changed substantially since the Court’s decision [dismissing the prior CSBS lawsuit].  The issuance of a [SPNB] charter is now clearly imminent.”  It further alleges that “upon information and belief, multiple pre-qualified candidates have already decided to apply (and may have already applied).”

The CSBS challenges the OCC’s SPNB charter plans in the new lawsuit on the following grounds (which generally track those asserted in the first CSBS lawsuit):

  • 12 C.F.R. Section 5.20(e)(1), on which the OCC has relied for its authority to charter a bank that performs a single core banking function—receiving deposits, paying checks, or lending money—is inconsistent with the National Bank Act because the NBA does not allow the OCC to charter entities that do not receive deposits unless they are carrying on a special purpose expressly authorized by Congress.
  • Because the OCC has indicated that state law would be preempted as to fintech companies that obtain a SPNB charter, the OCC’s plans to issue the charters represent a preemption determination to which notice and comment procedures apply.
  • The OCC’s plans to issue SPNB charters to fintech companies represent a “rule” that was made without compliance with the Administrative Procedure Act and is an arbitrary and capricious action that does not constitute “reasoned decision making” as required by the APA.
  • The OCC’s plans to issue SPNB charters to fintech companies, by enabling nonbank charter holders to disregard state law, violate the Tenth Amendment of the U.S. Constitution under which states retain the powers not delegated to the federal government, including the police powers necessary to regulate nonbank providers of financial services and protect consumers and the public interest from unsound and abusive financial practices.

For the reasons discussed in our blog post about the second lawsuit filed by the DFS, we expect the OCC’s power to issue an SPNB charter will ultimately be withheld.

At the Online Lending Policy Institute’s (OLPI) annual summit in Washington, D.C. earlier this week, the OCC’s recent decision to accept applications from non-depository financial technology firms for a special purpose national bank (SPNB) charter was the focus of considerable discussion.

The summit speakers included Grovetta Gardineer, the Senior Deputy Comptroller for Compliance and Community Affairs at the OCC.  Comments made by attendees indicated that there is substantial interest in the SPNB charter but a reluctance to be the first applicant due to concerns about litigation risk and regulatory requirements.  After the OCC announced its decision to accept applications, the Conference of State Bank Supervisors (CSBS) announced that it would again pursue litigation challenging the OCC’s recent decision.  While the CSBS has not yet filed another lawsuit and there is speculation that it is waiting until the first SPNB charter is granted to do so, a second lawsuit challenging the OCC’s authority to issue SPNB charters was filed last month by the New York Department of Financial Services (DFS) in New York federal district court.  (For an analysis of the DFS lawsuit, click here.)

In her remarks and responses to questions, Ms. Gardineer indicated that, although the Community Reinvestment Act does not apply to non-depository institutions, financial inclusion commitments from the SPNB charter applicant will be required and be subject to scrutiny by the OCC.  Questions directed at Ms. Gardineer raised concerns about the application of bespoke capital, liquidity, and risk management requirements for SPNB charter applicants.  And in response to questions about the charter’s implications for Federal Reserve requirements and access to Federal Reserve services, Ms. Gardineer indicated that the Federal Reserve was considering these issues and that they were the subject of ongoing discussions between the OCC and Federal Reserve.

Paul Watkins, recently named by CFPB Acting Director Mulvaney to serve as Director of the Bureau’s Office of Innovation, was also a speaker at the summit.  Mr. Watkins was formerly in charge of fintech initiatives in the Arizona Attorney General’s office, and Arizona is the first state to create a “regulatory sandbox” that allows new financial technologies and products to be tested in a controlled environment with reduced regulatory risk.  Mr. Watkins discussed the CFPB’s proposal to revise its Trial Disclosure Policy and suggested that the program could be used to address a broad range of issues.  For example, Mr. Watkins noted that a trial disclosure could be used to address challenges faced by creditors in supplying reasons for an adverse action where a decision is made through artificial intelligence or mechanical learning.  Mr. Watkins indicated that the CFPB’s no-action letter policy may also be subject to review by the Bureau.  Taken together, the trial disclosure and no-action letter policies appear to be the CFPB’s tools of choice for advancing its efforts to facilitate innovation that might be unduly limited by regulatory constraints.

A third summit speaker was Maria Vullo, DFS Superintendent.  Ms. Vullo expressed concern regarding the risks that “regulatory sandboxes” and trial disclosures can create for consumers where they are used for products and services actually offered in the marketplace rather than in a mock setting.  She also expressed concern about the potential for alternative data used in credit decisions to serve as a proxy for prohibited characteristics and suggested that an ability to repay standard should apply to all consumer credit and not be limited to mortgages and credit cards.

Finally, Adam Maarec, Of Counsel in Ballard’s D.C. Office, participated in a panel on data, privacy, and fraud prevention policy.  The panelists discussed the California Consumer Privacy Act’s potential application to financial institutions as a result of shortcomings in the exception for information “collected, processed, sold, or disclosed pursuant to” the Gramm-Leach-Bliley Act.  They also discussed ways for companies to manage the tension between data minimization and artificial intelligence/machine learning priorities, the latter of which depends on the accumulation of large data sets to identify insights.

In a press release, the organizers of Varo Bank, N.A. announced they have been granted preliminary approval by the OCC of their application to form a de novo national bank, which they claim “put[s] Varo on track to become the first all-mobile national bank in the history of the United States.”

In July 2018, the OCC announced that it would begin accepting applications for special purpose national bank (SPNB) charters from financial technology (fintech) companies.  Rather than a SPNB charter, Varo is seeking a full-service national bank charter from the OCC.  A SPNB charter provides an option for a fintech company for whom, because of its own non-financial activities or those of an affiliate, the Bank Holding Company Act would be an obstacle to obtaining a full-service national bank charter.  Obtaining a full-service national bank charter, however, is the preferred option for a fintech company that can do so consistent with the BHCA.  Many years ago, two of my Ballard partners successfully converted a consumer finance company to a full-service national bank.

Federal court lawsuits challenging the OCC’s authority to issue SPNB charters were filed in 2017 by the Conference of State Bank Supervisors and the New York Department of Financial Services.  Both lawsuits were dismissed for failure to establish an injury in fact necessary for Article III standing and lack of ripeness for judicial review.  While such challenges may be renewed now that the OCC has announced that it will begin accepting SPNB charter applications, there would not appear to be any basis for a similar challenge to the issuance of a full-service national bank charter to Varo assuming it satisfies the standard conditions for obtaining such a charter.

On January 30, 2018 at 10 a.m., the Financial Institutions and Consumer Credit Subcommittee of the House Financial Services Committee will hold a hearing, “Examining Opportunities and Challenges in the Financial Technology (“Fintech”) Marketplace.”

The Committee Memorandum states that the hearing “will examine the current regulatory landscape [for fintech], the need to amend or modernize the regulatory landscape or the necessity to amend existing financial laws or develop new legislative proposals that would allow financial services entities to use fintech to deliver new products and services to consumers.”

We find it surprising that neither Joseph Otting, the new Comptroller of the Currency, nor any other federal or state regulator, is slated to testify.  Mr. Otting has not yet taken a public position on the OCC’s proposal to issue special purpose national bank charters to companies that make loans but do not accept deposits.  However, two Ballard attorneys recently authored an article, “Predicting Comptroller Otting’s Impact on Fintech,” in which they expressed the view that he is likely to be supportive of such charters.

Jelena McWilliams, President Trump’s nominee for FDIC chair, is reported to have told Senators in her confirmation hearing last week that she did not believe the FDIC’s grant of industrial loan company charters to fintech and other nonbank firms would pose a safety and soundness risk for the broader financial system and intended to look into why the FDIC has delayed its review of applications for such charters.  Ms. McWilliams is also reported to have said that her position on moving quickly on those reviews should be seen as an invitation for more such charter applications.

 

 

Last week, the OCC announced that it had issued a full service national bank charter to Winter Park National Bank of Florida.

Acting Comptroller of the Currency Keith Noreika released a statement in which he stated that Winter Park is “the first de novo national bank and first de novo approved for federal deposit insurance in Florida since the financial crisis.”  He also commented that while the OCC was seeing “increasing interest in becoming new banks,” de novo banks continue to be “exceedingly rare.”  He then suggested that the charter process needs to be improved, stating “[m]aking the process of establishing de novo banks more efficient can only accelerate the recent positive trend and create more economic opportunity for consumers, businesses, and communities across the nation.”

In remarks last week at Georgetown University’s Institute of International Economic Law’s Fintech Week event, Acting OCC Comptroller Keith Noreika provided the “latest on our thinking regarding a charter for fintech companies that offer banking products and services.”

The Acting Comptroller began his remarks by expressing his “optimism about banks, fintech companies, and the business of banking as a whole.”  He also confirmed the OCC’s efforts to explore and support innovation, including by developing “a framework for OCC participation in bank-run pilots that allow banks to develop and test products in a controlled environment.”  He indicated that “[t]he idea behind our effort is to create principles that support the industry’s need for a place to experiment while furthering the OCC’s understanding of innovative products, services, and technologies. Information gathered in the pilots can inform OCC policies and help make sure that we are ready to supervise the new activity when rolled out on a larger scale.”

With regard to the OCC’s proposal to allow fintech companies to apply for a special purpose national bank (SPNB) charter, the Acting Comptroller first observed that because there was so much interest in the proposal, he felt it was important to provide an update on where we are in that process and to correct some misperceptions that I see out there.”

He then referenced his remarks in July 2017 in which he confirmed his view “that companies that offer banking products and services should be allowed to apply for national bank charters so that they can pursue their businesses on a national scale if they choose, and if they meet the criteria and standards for doing so.  Providing a path for these companies to become national banks is pro-growth, can reduce regulatory burden for those companies, and can bring enhanced services to millions of people served by the federal banking system.”

He also observed that national bank charters “will never be compulsory and should be just one choice for companies interested in banking,” existing as an option alongside other choices such as “becoming a state bank or state industrial loan company, or operating as a state-licensed financial service provider.”  He added that “[a] fintech company also has the option to pursue partnerships or business combinations with existing banks, or it could even consider buying a bank, if that makes sense.”

The Acting Comptroller commented that while such options exist, “[i]f, and it is still an if, a fintech company has ambitions to engage in business on a national scale and meets the criteria for doing so, it should be free to seek a national bank charter. That includes pursuing a charter under the agency’s authority to charter special purpose national banks or the agency’s long-existing authority to charter full-service national banks and federal saving associations, as well as other long-established limited-purpose banks, such as trust banks, bankers’ banks, and other so-called CEBA credit card banks.”  He observed that many fintech and online lending business models are a good fit for such categories of national bank charters, and noted that there was some interest in fintechs becoming full-service banks, trust banks, or credit card banks.

The Acting Comptroller described the OCC’s proposal to use its authority to charter nondepository fintech companies as “a work in progress,” and noted the challenges to such authority by the Conference of State Bank Supervisors and the New York Department of Financial Services and the OCC’s defense of its authority even though it has not yet decided whether it will exercise that specific authority.  He commented that before the OCC reaches a decision, it needs “to be certain that the companies expressing interest in becoming a national bank fully understand just what it means to be a bank” and that “[t]alking about and applying for are a long way from approval of an application, and even further away from resulting in the kind of harm and abuse suggested.”

He labeled the argument being made by opponents of the SPNB charter that it may be a “slippery slope toward the inappropriate mixing of banking and commerce” a concern “that I think has been exaggerated with the intent of scuttling our idea for a fintech charter.”  He commented that the suggestion “that such mixing would result in destabilizing the market and increase consumer abuses” is an idea that “has been blown out of proportion.”

He then described the process that the OCC might use in considering SPNB charter applications. The OCC would consider every application on its own merits.  Issues it might consider are whether: (1) the business plan is sound, (2) the proposed management team passes muster, (3) the proposed company has adequate capital and liquidity, (4) the proposed company has adequate processes for ensuring that it operates in a safe and sound manner, provides fair access, and treats customers fairly, and (5) the proposed company has a good chance to succeed.

The Acting Comptroller noted that there already are “dozens of examples where commercial companies are allowed to own banks at the state and federal levels without such abuse and harm—national credit card banks, state merchant processing banks, state-chartered ILCs” and commented that commercial companies are allowed to own such banks “for good reason—they support legitimate business goals and deliver valued products and services to their customers.”  He also stated that if a chartered bank does not meet the Bank Holding Company Act’s definition of what it means to be a bank for the purposes of the Act, “its parent company would not become a bank holding company solely by virtue of owning the bank, and therefore, nonbank holding companies, commercial entities, or other banks could own such banks under the law.”

He also indicated that he wanted to make it “crystal clear” that the chartered entity regulated by the OCC “would be a bank, engaged in at least one of the core activities of banking—taking deposits, paying checks, or making loans” and that those “who suggest that the OCC is considering granting charters to nonfinancial companies are wrong, and the more sophisticated ones know it.”  He cautioned that fear should not prevent “a constructive discussion of where commerce and banking coexist successfully today and where else it may make sense in the future.”

In Madden, the Second Circuit ruled that a nonbank that purchases loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act allows the national bank to charge.  Yesterday, at the Online Lending Policy Summit in Washington, D.C., Acting OCC Comptroller Keith Noreika advocated a Madden “fix” as an example of an action Congress could take “to reduce burden and promote economic growth.”  Mr. Noreika stated that the OCC supports proposed legislation that would codify the “valid when made rule” and provide that a loan that is made at a valid interest rate remains valid at that rate after it is transferred.

During the Q&A following Mr. Noreika’s remarks, I asked whether the OCC would consider issuing an interpretive opinion to address Madden should Congress fail to act.  Unlike former Comptroller Curry, who we criticized for his reluctance to weigh in on the issue, Mr. Noreika responded that the OCC would “not be hesitant” to formally address the “valid when made” rule.

Mr. Noreika also was asked whether, as we have previously suggested, the OCC would address the risk posed by the theory that a bank making loans is not the “true lender” if a nonbank marketing and servicing agent acquires the “predominant economic interest” in the loans.  Unfortunately, Mr. Noreika stated that “true lender” guidance might be unnecessary at this time due to prior guidance issued during the tenures of former Comptrollers Hawke and Duggan.  Mr. Noreika acknowledged that the OCC’s views were not being followed uniformly by the courts, and we do not think the OCC has been sufficiently clear on the issue.  Accordingly, we remain hopeful that the OCC will involve itself here, as well, and will make it clear that Section 85 fully applies to loans made by national banks, even if a nonbank agent of the bank has the predominant economic interest in the loans.

With regard to the OCC’s special purpose national bank (SPNB) charter proposal, Acting Comptroller Noreika stated (as he previously did in July 2017) that the OCC is continuing to consider the proposal and intends to defend its authority to grant an SNPB charter to a nondepository company in the lawsuits filed by the NY Department of Financial Services and the Conference of State Bank Supervisors.  Remarking that “we will keep you posted,” however, he remained noncommittal about what the OCC’s ultimate position would be on implementing the proposal and again suggested that fintech companies consider seeking a national bank charter by using more established OCC authority such as trust banks and bankers’ banks.  For a fintech company that is not part of a corporate group engaged in nonfinancial activities prohibited by the Bank Holding Company Act, a standard national bank charter may remain a better option.

Indeed, we have previously suggested that a non-bank marketplace lender should consider conversion to a standard national bank.  Many years ago, two of my Ballard partners successfully converted a consumer finance company to a standard national bank with the right to export throughout the country “interest” (as broadly defined under the OCC’s regulations) as permitted by its home state and to accept FDIC-insured deposits.

Mr. Noreika also indicated that the OCC intends to revisit its guidance on deposit advance products, observing that its views on such products are not necessarily consistent with those of the CFPB.  In November 2013, the OCC issued final guidance that made it impractical for many banks to provide or continue to provide deposit advance services.  Since the CFPB’s final payday loan rule is expected to cover deposit advance loans, there will be a need to reconcile any new OCC guidance with the CFPB’s rule.

Finally, Acting Comptroller Noreika referenced his letter sent last month to House Financial Services Committee Chairman Jeb Hensarling in which he “added [his] voice to that chorus in letters to Congress denouncing Operation Chokepoint.”  “Operation Chokepoint” was a federal enforcement initiative allegedly involving both the DOJ and the federal banking agencies, that targeted banks serving online payday lenders and other lawful companies that have raised regulatory or “reputational” concerns.  A lawsuit brought by the payday lending industry, challenging Operation Chokepoint, is ongoing.  In a tone that conveyed strong conviction, Mr. Noreika indicated that it was not the OCC’s policy to direct banks to close entire categories of accounts without assessing the risks presented by individual customers or the bank’s ability to manage such risks. Mr. Noreika observed that “banks make the decisions to retain or terminate customer relationships, not the regulators, and not the OCC.”

I left the meeting much encouraged with the direction the OCC appears to be taking.