Acting Comptroller of the Currency Keith Noreika, in remarks on July 19 to the Exchequer Club, confirmed that the OCC is continuing to consider its proposal to allow financial technology (fintech) companies to apply for a special purpose national bank (SPNB) charter.  Since the departure of the SPNB proposal’s architect, former Comptroller Thomas Curry, who Mr. Noreika replaced, there has been considerable speculation as to what position the OCC would take on the proposal.

In his remarks, Acting Comptroller Noreika referenced the lawsuits filed by the New York Department of Financial Supervision and the Conference of State Bank Supervisors challenging the OCC’s authority to grant SPNB charters to fintech companies.  He indicated that in these lawsuits, the OCC plans to “vigorously” defend its authority to rely on its regulation at 12 C.F.R. section 5.20(e)(1) to grant SPNB charters to nondepository companies.  He also countered arguments that granting SPNB charters to fintech companies would disadvantage banks and create consumer protection risks.  (As we have previously observed, both lawsuits present a lack of ripeness and/or no case or controversy problem.)

At the same time, referring to the proposal as “a good idea that deserves the thorough analysis and the careful consideration we are giving it,” Mr. Noreika was noncommittal about what the OCC’s ultimate position would be.  Despite his statement that the OCC plans to defend its charter authority in the lawsuits, Mr. Noreika also stated that “the OCC has not determined whether it will actually accept or act upon applications from nondepository fintech companies for special purpose national bank charters that rely on [section 5.20].  And, to be clear, we have not received, nor are we evaluating, any such applications from nondepository fintech companies.  The OCC will continue to hold discussions with interested companies while we evaluate our options.”

Acting Comptroller Noreika suggested that fintech companies consider seeking a national bank charter by using other OCC authority “to charter full-service national banks and federal savings associations, as well as other long-established special purpose national banks, such as trust banks, banker’s banks, and other so-called CEBA credit card banks.”  According to Mr. Noreika, the state plaintiffs in the lawsuits had conceded that the OCC has such other authority.  Observing that many fintech business models may fit into the established categories of special purpose national banks “that do not rely on the contested provision  of regulation, section 5.20,” he stated that “we may well take [the states] up on their invitation to use these [other] authorities in the fintech-chartering context.” (emphasis included).

Many years ago, we were successful in converting a consumer finance company to a national bank and had no difficulty in obtaining OCC approval.  Nonbanks engaged in interstate consumer lending should consider conversion as an option since it enables the converted bank to (1) export throughout the country “interest” (as broadly defined under the OCC’s regulations) as permitted by its home state, (2) disregard non-interest state laws that impair materially the exercise of national bank powers, and (3) accept FDIC-insured deposits, which generally are the lowest cost source of funds.  Nonbanks engaged in non-financial activity or with affiliates engaged in such activity may be limited to SPNB conversions due to activity restrictions in the Bank Holding Company Act.

The OCC’s proposal to create a fintech charter would, if finalized, help some companies partially avoid the negative impact of the Second Circuit’s decision in Madden v. Midland Funding.  (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.)  It would also help some fintech companies deal with the risk of a court or enforcement authority concluding that the fintech company, and not its bank partner, is the “true lender.”  Treating a nonbank as the “true lender” would subject the nonbank to usury, licensing, and other limits to which its bank partner would not otherwise be subject.

The “true lender” risk, which is not confined to the fintech space but can arise in many bank-partner-model arrangements, is a live issue.  In litigation currently ongoing in federal district court in Colorado, two state-chartered banks are seeking to enjoin enforcement actions brought by the Colorado Uniform Consumer Credit Code Administrator against the banks’ nonbank partners that market and service loans originated by the banks and purchase loans from the banks.  The Administrator has alleged that because the banks were not the “true lenders” on the loans sold to the banks’ partners, the loans are subject to Colorado law regarding interest, not the law of the states where the banks are located.

Unfortunately, as set forth in Alan Kaplinsky’s article for American Banker’s BankThink, the possibility that the OCC might charter SPNBs (or deposit-taking fintech national banks) does not fully address the Madden and “true lender” risks facing fintech companies, their bank partners, or other entities involved in “bank-model” lending programs.  The SPNB proposal has not been adopted and may be overturned in litigation.  It does not extend to non-fintech companies.  In many respects, it includes burdensome provisions.  And Madden risks would remain for loan purchasers.

We believe that recent developments, both in Colorado and elsewhere, highlight the need for the OCC to confront true lender and Madden risks directly.  This could (and should) be accomplished through adoption of a rule: (1) providing that loans funded by a bank in its own name as creditor are fully subject to Section 85 and other provisions of the National Bank Act for their entire term; and (2) emphasizing that banks that make loans are expected to manage and supervise the lending process in accordance with OCC guidance and will be subject to regulatory consequences if and to the extent that loan programs are unsafe or unsound or fail to comply with applicable law.  (The rule should apply in the same way to federal savings banks and their governing statute, the Home Owners’ Loan Act.)  In other words, it is the origination of the loan by a supervised bank (and the attendant legal consequences if the loans are improperly originated), and not whether the bank retains the predominant economic interest in the loan, that should govern the regulatory treatment of the loan under federal law.

 

 

 

This past Thursday, by a  vote of 31-21, the House Appropriations Committee approved the fiscal year 2018 Financial Services and General Government Appropriations bill.  In addition to multiple provisions to reform the CFPB, the bill contains a provision intended to override the Second Circuit’s opinion in Madden v. Midland Funding.  In Madden, the court held that a non-bank transferee of a loan from a national bank loses the ability to charge the same interest rate that the national bank charged on the loan under Section 85 of the National Bank Act.

The CFPB reforms are:

  • Bringing the CFPB into the regular appropriations process (Section 926)
  • Eliminating the CFPB’s supervisory authority (Section 927)
  • Removing the CFPB’s “rulemaking, enforcement, or other authority with respect to payday loans, vehicle title loans or other similar loans” (Section 928)
  • Removing the CFPB’s UDAAP authority (Section 929)
  • Repealing the CFPB’s authority to restrict arbitration (Section 930)

Section 925 of the Appropriations bill, which would override the Second Circuit’s Madden opinion, is identical to a provision in the CHOICE Act passed by the House.  The bill would add the following language to Section 85: “A loan that is valid when made as to its maximum rate of interest in accordance with this section shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be enforced by such third party notwithstanding any State law to the contrary.”  Like the CHOICE Act, the Appropriations Bill would also add the same language (with the word “section” changed to “subsection” when appropriate) to the provisions in the Home Owners Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal savings associations, federal credit unions, and state-chartered banks.  (While these statutory amendments would be welcome, Alan Kaplinsky pointed out in an article for American Banker’s BankThink that the OCC could more simply and quickly accomplish the same objective for national banks by issuing a regulation.)

 

 

 

Last Thursday, by a party-line vote of 34-26, the House Financial Services Committee approved the Financial CHOICE Act (H.R. 10) proposed by Committee Chairman Jeb Hensarling.

In addition to overhauling the CFPB’s structure and authority, the bill would make significant changes to the rulemaking process followed by the CFPB and other financial services regulators, including the Fed, FDIC, OCC and NCUA.  It would also override the Second Circuit’s controversial opinion in Madden v. Midland Funding by codifying the “valid when made” rule and repeal the women- or minority-owned businesses and small business data collection requirements added to the ECOA by Section 1071 of Dodd-Frank.

Key CFPB changes include the following:

  • The CFPB would be renamed the “Consumer Law Enforcement Agency” (CLEA).  It would be led by a single Director appointed by the President and confirmed by the Senate.  There would be no “for cause” limit on the President’s authority to remove the CLEA Director and the Deputy Director would also be appointed by the President.
  • The CLEA would have no supervisory authority, no UDAAP enforcement or rulemaking authority, no enforcement or rulemaking authority “with respect to payday loans, vehicle title loans, or other similar loans,” and no authority to prohibit or limit the use of arbitration agreements in connection with consumer financial products or services.
  • The CFPB’s 2013 indirect auto finance guidance would be nullified and any such future guidance would be subject to various requirements that include advance public notice and a comment period.
  • The Office of Information and Regulatory Affairs (OIRA) would “have the same duties and authorities with respect to the [CLEA] as the [OIRA] has with respect to any other agency that is not an independent regulatory agency.”  Presumably, this means proposed and final CLEA regulations would be subject to OIRA review.
  • The CLEA would be subject to the regular Congressional appropriations process.  (The OCC, FDIC and NCUA would also be brought in to the appropriations process.)
  • The CLEA would have its own Inspector General.
  • A party to a CLEA administrative proceeding that could result in a cease and desist order or penalty could require the CLEA to terminate the proceeding, thereby requiring the CLEA to bring a civil action should it wish to pursue the same remedies.
  • The recipient of a CID could file a petition to modify or set aside the CID with a federal district court.
  • An Office of Economic Analysis would be created within the CLEA to conduct an impact analysis of all proposed rules, conduct follow up reviews of final rules at designated intervals to measure the rule’s success in meeting its objectives, and conduct a cost-benefit analysis of a proposed administrative action, civil lawsuit, or consent order.
  • The Director of the CLEA would be required to establish a procedure for the issuance of advisory opinions.
  • The CLEA would be required to maintain a segregated account in the Civil Penalty Fund for all civil penalties it receives.  Any funds not distributed to victims of the violations for which the penalties were collected that remain in the segregated account after 2 years would have to be deposited in the general U.S. Treasury.

Key changes to rulemaking process include the following:

  • The CLEA, Fed, FDIC, OCC, NCUA, SEC, FHFA, and Commodity Futures Trading Commission (federal financial agencies) would be required to include specified information in notices of proposed and final rulemaking.  Such information is similar to the information that currently must be provided to OIRA by federal agencies, other than those defined as an “independent regulatory agency, under Executive Order 12866 for proposed and final regulations constituting a “significant regulatory action.”  That information includes an assessment of a regulation’s anticipated costs and benefits and an identification and assessment of available alternatives.
  • Before a rule can take effect, a federal financial agency must publish in the Federal Register “a list of information on which the rule is based, including data, scientific and economic studies, and cost-benefit analysis” and submit a report to Congress containing specified information that includes a classification of the rule as “major” or “nonmajor.”  A major rule is a rule that it is likely to result in (a) an annual effect on the economy of $100 million or more, (b) a significant increase in costs or prices for consumers, individual industries, federal, state or local government agencies or geographic regions, or (c) significant adverse effects on competition, employment, investment, productivity, innovation, or the ability of U.S.-based businesses to compete with foreign-based businesses in domestic and export markets.
  • A major rule cannot take effect until Congress enacts a joint resolution of approval. A nonmajor rule is subject to disapproval by a joint resolution.  The bill specifies the procedures for joint resolutions of approval and disapproval.
  • Chevron deference would not apply to judicial review of a federal financial agency’s action.  A court would be required to “decide de novo all relevant questions of law, including the interpretations of constitutional and statutory provisions, and rules made by an agency.”
  • An agency could not use the proceeds of a settlement for payments to persons who were not victims of the alleged wrongdoing.

The CHOICE Act bill would override the Second Circuit’s opinion in Madden v. Midland Funding, in which the court held that a non-bank transferee of a loan from a national bank loses the ability to charge the same interest rate that the national bank charged on the loan under Section 85 of the National Bank Act.  The bill would add the following language to Section 85: “A loan that is valid when made as to its maximum rate of interest in accordance with this section shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be enforced by such third party notwithstanding any State law to the contrary.”  The same language (with the word “section” changed to “subsection” when appropriate) would also be added to the provisions in the Home Owners Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal savings associations, federal credit unions, and state-chartered banks.  (While these statutory amendments would be welcome, Alan Kaplinsky recently pointed out in a recent article for American Banker’s BankThink that the OCC could more simply and quickly accomplish the same objective for national banks by issuing a regulation.)

Finally, the CHOICE Act bill would repeal Section 704B of the ECOA, the amendment made to the ECOA by Section 1071 of Dodd-Frank to require financial institutions to collect and maintain certain data in connection with credit applications made by women- or minority-owned businesses and small businesses.

The bill must now be considered by the full House.  A vote on the bill could happen before the end of this month.

 

 

The Administrator of the Uniform Consumer Credit Code for the State of Colorado, Julie Ann Meade, has filed motions to dismiss the complaints filed in federal court by two state-chartered banks seeking to permanently enjoin enforcement actions brought by the Administrator against the banks’ nonbank partners.  According to the complaints, these nonbank partners market and service loans originated by the banks, and the banks sometimes sell these loans to their partners.

In the enforcement actions, the Administrator takes the position that the banks are not the “true lender” of the loans, and that, pursuant to the Second Circuit’s decision in Madden v. Midland Funding, LLC, the banks could not validly assign their ability to export interest rates under federal law.  Accordingly, the enforcement actions assert that the loans sold to the banks’ partners are subject to Colorado usury laws despite the fact that state interest rate limits on state bank loans are preempted by Section 27 of the Federal Deposit Insurance Act.  The banks’ complaints allege that the Administrator’s enforcement actions disregard two fundamental principles of banking law—the banks’ right to “export” their respective home state’s interest rates to borrowers in other states under Section 27, and the “valid-when-made” rule.

In her motions to dismiss, the Administrator makes the following arguments:

  • Under the “well-pleaded complaint rule,” the court has no subject matter jurisdiction over the complaints because they seek to assert a federal preemption defense to the enforcement actions and such a defense does not, by itself, give rise to a federal question.  The Administrator argues that although the U.S. Supreme Court has held that state usury claims against a national bank are completely preempted notwithstanding the well-pleaded complaint rule, complete preemption does not apply to state usury claims against state-chartered banks.
  • The banks lack standing because the enforcement actions are only directed against the non-bank partners and any injury alleged by the banks, such as the actions’ impact on the secondary investor market or loss of revenue, is too attenuated.
  • The complaints fail to state a claim under Rule 12(b)(6) because under relevant federal banking laws and case law (such as Madden), only banks have interest exportation rights and such rights do not preempt state law as applied to non-banks.  In addition, the U.S. Supreme Court cases cited by the banks to support their “valid-when-made” argument are not relevant precedent because they addressed whether promissory notes created in non-usurious loans become unenforceable when used as collateral or discounted in subsequent usurious transactions.  (According to the Administrator, the OCC, in arguing in its amicus brief filed with the Supreme Court in Madden that the “valid-when-made” rule applies to assignees of national bank loans, relied upon a similar “misunderstanding of the holding” in such cases.)
  • The non-banks removed the enforcement actions to federal court and the Administrator has filed remand motions.  Assuming the remand motions are granted, the court should abstain from hearing the complaints under the Younger doctrine because there would be a state proceeding that provides an adequate forum for the banks’ federal claims and the state proceeding involves important state interests.  Alternatively, the court should decline to exercise its jurisdiction under the Declaratory Judgments Act because a declaration is not needed to resolve the legal issues raised in the case as they will necessarily be decided in the enforcement action.

We will continue to follow the banks’ lawsuits and the Administrator’s enforcement actions.

In a recent blog post, Alan Kaplinsky and Scott Pearson wrote about the remarks made by CFPB Director Richard Cordray and Comptroller of the Currency Thomas Curry at the LendIt USA conference in New York City earlier this month.  In the blog post, we expressed our strong disagreement with Comptroller Curry’s refusal to author an interpretive opinion to address the disruption in the lending markets caused by the Second Circuit’s Madden decision and promised to share our reasons at a later date for why we think that the OCC should go even further and propose a rule to address Madden 

Alan has now written an article published in BankThink, American Banker’s “platform for informed opinion about the ideas, trends and events reshaping financial services,” that urges the OCC to issue a rule to address Madden.  In Madden, the Second Circuit ruled that a company 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.  As Alan demonstrates in his article, there is clear OCC and U.S. Supreme Court precedent for the OCC to issue an interpretive opinion or regulation interpreting Section 85 to address an issue that is being litigated and the Supreme Court has indicated that it can properly do so.  As he also demonstrates, the need for an OCC rule is not eliminated by the OCC’s proposal to create a national bank charter for financial technology companies.