The Office of the Comptroller of the Currency (OCC) has filed a motion to dismiss the lawsuit filed by the New York Department of Financial Services (DFS) challenging the OCC’s authority to grant special purpose national bank (SPNB) charters to nondepository fintech companies.

The DFS lawsuit, which was filed in May 2017 in a New York federal district court, is similar to the lawsuit filed in April 2017 by the Conference of State Bank Supervisors (CSBS) in D.C. federal district court.  Earlier this month, the OCC filed a motion to dismiss the CSBS lawsuit.

The arguments made by the OCC in support of its motion to dismiss the DFS lawsuit track those made in support of its motion to dismiss the CSBS lawsuit.  Most notably, the OCC again makes the central argument that because it has not yet decided whether it will offer SPNB charters to companies that do not take deposits, the DFS complaint should be dismissed for failing to present either a justiciable case or controversy under the U.S. Constitution or a reviewable final agency action under the Administrative Procedure Act.

In remarks given last month, Acting Comptroller Keith Noreika confirmed that the OCC is continuing to consider its SNPB charter proposal despite the departure of the SPNB proposal’s architect, former Comptroller Thomas Curry, who Mr. Noreika replaced.  While indicating that the OCC planned to vigorously defend its authority to grant an SNPB charter to a nondepository company in the DFS and CSBS lawsuits, Mr. Noreika was noncommittal about what the OCC’s ultimate position would be on implementing the proposal.  He also suggested that fintech companies consider seeking a national bank charter by using more established OCC authority.

A new research paper released by the Federal Reserve Bank of Philadelphia found that fintech lending has expanded consumers’ ability to access credit.  The paper, “Fintech Lending: Financial Inclusion, Risk Pricing, and Alternative Information,” used account-level data provided by a large fintech lender to “explore the advantages/disadvantages” of loans made by such lender “and similar loans that were originated through traditional banking channels.”

The study’s key findings include:

  • The fintech lender’s consumer lending activities penetrated into areas that could benefit from additional credit supply, such as areas that have lost a disproportionate number of bank branches and highly concentrated banking markets.
  • Consumers presenting the same credit risk could obtain credit at lower rates through the fintech lender than through traditional credit cards offered by banks.
  • The lender’s use of alternative credit data allowed consumers with few or inaccurate credit records (based on FICO scores) to access credit at lower prices, thereby resulting in enhanced financial inclusion.

In February 2017, the CFPB issued a request for information that seeks information about the use of alternative data and modeling techniques in the credit process.

On August 3, 2017, the Consumer Financial Protection Bureau (CFPB) provided the mortgage industry with a first look at the portal to be used for the reporting of, and public access to, data under the Home Mortgage Disclosure Act (HMDA).  Reporting institutions will use the portal to submit data commencing with the submission of calendar year 2017 data by March 1, 2018.  Also, instead of making their HMDA report and modified Loan Application Register (LAR) available to the public, reporting institutions will direct members of the public to the HMDA portal for this information.  The presentation was conducted by Michael Byrne, a Project Director in the Technology Division with the CFPB.  The presentation addressed only the data submission aspects of the portal, and not the ability to access HMDA data that is publicly available.

The portal was created by the CFPB in conjunction with the significant revisions to the HMDA rule.  As we have reported previously, most of revisions are scheduled to be implemented on January 1, 2018.  Nevertheless, initially the portal will be available only for the submission of the current HMDA data fields, which must be collected for 2017 activity and reported in 2018.

The portal is not yet available for access.  Mr. Byrne advised that the CFPB plans to make a Beta version of the portal available around the end of the third quarter, and that the CFPB will use input from the Beta period to revise the portal during the fourth quarter prior to the final version being released.  The CFPB also plans to release a check digit tool for use in verifying the universal loan identifier, and a geocoder tool, during the fourth quarter.

Once the portal becomes live, persons responsible for HMDA reporting at their institution will need to create an account to be able to access the portal.  The portal includes a series of steps to validate the accuracy and correct formatting of the data in a LAR before it can actually be submitted.  The CFPB has a File Format Verification Tool that institutions can use to test whether their 2017 HMDA data is formatted correctly.   The CFPB plans to issue a File Format Verification Tool for the revised HMDA data categories.  Data for the revised categories will first be collected for the 2018 reporting year, and reported in 2019.

Mr. Byrne advised that for institutions with a smaller volume of loans who elect to use the Excel-based LAR Formatting Tool that is available on the CFPB website, the CFPB designed the tool to convert the data into the format necessary to submit the data through the HMDA  portal.  The CFPB plans to issue a version of the LAR Formatting Tool for the revised HMDA data categories later this year.

For institutions that collect HMDA data with multiple LARs, they will be able to use the multiple LARS to test the data on the portal before submission.  However, to submit the data institutions will need to combine the multiple LARS into a single LAR file.

The Office of the Comptroller of the Currency (OCC) has filed a renewed motion to dismiss the lawsuit filed by the Conference of State Bank Supervisors (CSBS) in D.C. federal district court challenging the OCC’s authority to grant special purpose national bank (SPNB) charters to fintech companies.  The OCC had filed the motion several days earlier but was required to file a renewed motion to reduce the number of footnotes.  Except for adding a new statute of limitations argument, the arguments in the new memorandum in support of the motion track those made in the initial memorandum.

The OCC’s central argument for dismissal is that because it has not yet decided whether it will offer SPNB charters to companies that do not take deposits, the CSBS complaint should be dismissed for failing to present either a justiciable case or controversy under the U.S. Constitution or a reviewable final agency action under the Administrative Procedure Act (APA).  More specifically, the OCC argues that:

  •  CSBS cannot establish standing necessary to meet the Article III “case or controversy” requirement because the OCC has not yet taken any relevant action that could have a concrete effect on CSBS or its members—no SPNB charter has been issued to a non-deposit taking bank, the OCC has not received any applications to charter such a bank, no final procedures for processing such applications are in place, and the OCC’s public statements about the SPNB charter were part of ongoing policy development that is not final.
  • The actions taken by the OCC that are referred to as the “Nonbank Charter Decision” in the CSBS complaint are nothing more than a collection of non-final policy papers and solicitations for public input that do not represent a “final agency action” subject to review under the APA.
  • Because no final agency action has taken place, the court should conclude that the matter is not ripe for judicial review.

The OCC’s other arguments for dismissal include:

  • If the adoption of the amendments to the OCC’s chartering regulations (12 C.F.R. Section 5.20(e)(1)) that would allow the OCC to charter a bank that does not receive deposits constituted a final agency action, an APA cause of action accrued in January 2004 when the final rule became effective.  Since an APA action is subject to a six-year statute of limitations, the time for filing an APA challenge expired in January 2010.
  • Even if the court were to reach the merits of the validity of Section 5.20(e)(1), the complaint should be dismissed for failure to state a claim because, under Chevron, the provision represents a reasonable interpretation of the undefined and ambiguous term “business of banking” in the National Bank Act.
  • CSBS’ argument that the OCC’s authority under the NBA to charter an entity to “commence the business of banking” does not give the OCC authority to charter a national bank that does not accept deposits is without merit for reasons that include contrary U.S. Supreme Court and D.C. Circuit authority.

Democratic Senator Mark Warner has introduced a bill, S.1642, that would override 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.)  The bill would add the following language to Section 85 of the National Bank Act: “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.”

This language is identical to language in the Financial CHOICE Act and the Appropriations Bill that is also intended to override Madden.  Like the Financial CHOICE Act and Appropriations Bill, the Senate bill would 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.

Unlike the CHOICE Act and Appropriations Bill, however, the Senate bill includes “findings” that appear intended to avoid the bill from being characterized as a change in the law.  The findings state that the valid-when-made doctrine is an “important and longstanding principle [that] derives from the common law and its application has been a cornerstone of United States banking law for nearly 200 years.”  They also explain why there is a need for the doctrine to be “reaffirmed soon by Congress.”

Like the adoption of the OCC’s proposal to create a fintech charter, the enactment of legislation reaffirming the valid-when-made doctrine would help some companies avoid Madden’s negative impact.  However, it would not help 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.

As a result, even if “valid-when-made” legislation is enacted, there would still be a need for the OCC to confront the true lender risk directly, something we have previously urged it to do.  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.

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.

 

 

 

Congressman Emanuel Cleaver, II announced last week that he had launched an investigation into small business financial technology (fintech) lending by sending a letter to the CEOs of several fintech small business lenders.  The letter includes 10 questions and asks for responses to be provided by no later than August 10, 2017.

In the letter, Mr. Cleaver expressed concern that “some FinTech lenders may be trapping small business owners in cycles of debt or charging higher rates to entrepreneurs of color.”  He noted that he is “particularly interested in payday loans for small businesses, also known as ‘merchant cash advance.'”  He observed that “current law does not provide certain protections for small business loans, compared to other consumer laws,” and cited Truth in Lending disclosures given to consumers as an example of such difference.  He also observed that fintech lenders are not subject to the same level of scrutiny as small community banks and credit unions which are subject to supervision for compliance with anti-discrimination laws.

The questions set forth in Mr. Cleaver’s letter include inquiries about a lender’s small business products and originations, approach to protecting borrowers belonging to protected classes, percentage of “loan and advances [that] are originated to borrowers of color [and] [w]omen,” “the typical rate charged to borrowers of color as compared to [the lender’s] overall borrower population,” typical fee schedule for small business lending products, and use of mandatory arbitration agreements.  In his announcement about the letter, Mr. Cleaver listed the lenders to whom his letter was sent.  We understand that most of such lenders do not make small business loans.

This past March, Mr. Cleaver sent a letter to the CFPB in which he asked the agency to investigate whether fintech companies were complying with anti-discrimination laws, including the Equal Credit Opportunity Act.  Mr. Cleaver also asked the CFPB to respond to a series of questions that included when the CFPB anticipated finalizing regulations to implement Dodd-Frank Section 1071.  Section 1071 amended the ECOA 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 Financial CHOICE Act passed this month by the House includes a repeal of Section 1071 and the Treasury report issued this month recommended that Section 1071 be repealed.

 

 

The OCC announced that its Office of Innovation will host office hours for national banks, federal savings associations, and financial technology (fintech) companies from July 24 through July 26, 2017 at the OCC’s district office in New York City.  According to the OCC, the office hours are intended to “provide an opportunity for meetings with OCC officials to discuss financial technology, new products or services, partnering with a bank or fintech company, or other matters related to financial innovation.”

The OCC stated that its staff “will provide feedback and respond to questions” and that each meeting will be no longer than one hour.  Persons wishing to meet with the OCC can request a meeting through July 5 and are expected to indicate the reason for their interest in having the meeting.  The OCC plans to hold office hours in other cities at later dates.  (An initial round of office hours meetings took place in San Francisco last month.)

Last October, the OCC announced that it was creating the Office of Innovation to serve as an office dedicated to responsible innovation and to implement a formal framework to improve the agency’s ability to identify, understand, and respond to financial innovation affecting the federal banking system.  The announcement followed the OCC’s release last spring of a white paper, “Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective.”  The white paper was part of an initiative announced by former Comptroller Thomas J. Curry in August 2015 to develop a comprehensive framework to improve the OCC’s ability to understand innovation in the financial services industry, and to help national banks and federal savings associations in the face of  increasing competition from fintech companies.  In December 2016, the OCC announced its proposal to allow fintech companies to apply for special purpose national bank (SPNB) charters and, in March 2017, it issued a draft supplement to its existing Licensing Manual for SPNB charters as well as its responses to comments received on its SPNB charter proposal.

It is unclear whether the latest office hours announcement can be read as an indication of continuing OCC support for the SPNB charter proposal following Mr. Curry’s departure.  Last month, Keith Noreika was appointed by President Trump to serve as Deputy Comptroller and began serving as Acting Comptroller on May 5.  It has since been widely reported that President Trump will nominate Joseph Otting to replace Mr. Curry as Comptroller.  Neither Mr. Noreika or Mr. Otting is known to have yet taken a public position with respect to the SPNB charter.

 

 

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The Office of the Comptroller of the Currency has issued a new bulletin (2017-21) containing fourteen frequently asked questions to supplement OCC Bulletin 2013-29 entitled “Third-Party Relationships: Risk Management Guidance.”   The 2013 bulletin provided updated guidance for managing operational, compliance, reputation, strategic, and credit risk presented by third-party business relationships of national banks and federal savings associations.

In the new bulletin, the OCC observes that many banks have recently developed relationships with financial technology (fintech) companies in which the fintech companies perform or deliver services on behalf of a bank or banks and therefore meet the 2013 bulletin’s definition of a third-party relationship.  The OCC states that, as a result, it would expect bank management to include such fintech companies in the bank’s third-party risk management process.  The FAQs include the following specifically addressed to fintech companies:

  • Is a fintech company arrangement considered a critical activity?
  • Can a bank engage with a start-up fintech company with limited financial information?
  • How can a bank offer products or services to underbanked or underserved segments of the population through a third-party relationship with a fintech company?

The FAQs also specifically address bank arrangements with marketplace lenders, in particular the question “What should a bank consider when entering into a marketplace lending arrangement with nonbank entities?”  The OCC’s guidance includes the following:

  • For compliance risk management, banks should not originate or support marketplace lenders that do not have adequate compliance management processes and should monitor the marketplace lenders to ensure that they appropriately implement applicable consumer protection laws, regulations, and guidance.
  • When banks enter into marketplace lending or servicing arrangements, because the banks’ customers may associate the marketplace lenders’ products with those of the banks, reputation risk can arise if the products underperform or harm customers.
  • Operational risk can increase quickly if the banks and the marketplace lenders do not include appropriate limits and controls in their operational processes, such as contractually agreed-to loan volume limits and proper underwriting.
  • To address the risks created by marketplace lending arrangements, a bank’s due diligence of marketplace lenders should include consulting with the bank’s appropriate business units, such as credit, compliance, finance, audit, operations, accounting, legal, and information technology.
  • Contracts or other governing documents should set forth the terms of service-level agreements and contractual obligations, and significant contractual changes should prompt reevaluation of bank policies, processes, and risk management practices.

The CFPB recently announced that it has begun to examine service providers on a regular, systematic basis, particularly those supporting the mortgage industry.  Previously, the CFPB has only examined some service providers on an ad hoc basis.  The change represents a significant expansion of the CFPB’s use of its supervisory authority and will substantially increase the number and types of entities facing CFPB examinations.  On June 13, 2017, from 12 p.m. to 1 p.m. ET, Ballard Spahr attorneys will hold a webinar, “The CFPB’s Expansion of its Supervisory Program to Service Providers – What You Need to Know.”  More information and a link to register is available here.

 

 

 

The New York Department of Financial Supervision (DFS) has filed a complaint in a New York federal district court to stop the Office of the Comptroller of the Currency (OCC) from implementing its proposal to issue special purpose national bank (SPNB) charters to fintech companies.  The lawsuit follows the filing of a similar action earlier this month by the Conference of State Bank Supervisors (CSBS) in D.C. federal district court.

Like the CSBS lawsuit, the DFS lawsuit challenges the OCC’s proposal on the grounds that:

  • The National Bank Act (NBA) does not allow the OCC to charter non-depository financial services
  • The OCC’s decision to issue SPNB charters to fintech companies, by enabling non-depository charter holders to disregard state law, violates the Tenth Amendment of the U.S. Constitution under which states retain the powers not delegated to the federal government, including the police power to regulate financial services and products delivered within a state

In defending its authority to charter SPNBs that do not take FDIC-insured deposits, the OCC has relied on 12 C.F.R. Section 5.20(e)(1) which allows the OCC to charter a bank that performs a single core banking function—receiving deposits, paying checks, or lending money.  Similar to the CSBS lawsuit, the relief sought by the DFS lawsuit includes a declaration that the OCC lacks authority under the NBA to issue SPNB charters to fintech companies that do not take deposits, a declaration that 12 C.F.R. Section 5.20(e)(1) is null and void because it exceeds the OCC’s authority under the NBA, and an injunction prohibiting the OCC from issuing SPNB charters as proposed.

We have commented that because the OCC has not yet finalized the licensing process for fintech companies seeking an SPNB charter, the CSBS is likely to face a motion to dismiss on grounds that include a lack of ripeness and/or no case or controversy.  The DFS is likely to also face a motion to dismiss on similar grounds.  Perhaps anticipating an argument that it lacks standing to bring the lawsuit because it cannot show actual harm, DFS alleges not only that the OCC proposal would undermine its ability to protect New York consumers but also that the OCC’s actions will “injure DFS in a directly quantifiable way.”  DFS alleges that because its operating expenses are funded by assessments levied on New York-licensed financial institutions, every company that receives an SPNB charter “in place of a New York license to operate in this state deprives DFS of crucial resources that are necessary to fund the agency’s regulatory function.”

This allegation does not seem sufficient to overcome the lack of ripeness and/or no case or controversy problem that the DFS lawsuit presents.  Indeed, the DFS filed its lawsuit after the architect of the SPNB charter proposal, former Comptroller of the Currency Thomas Curry, was replaced by Acting Comptroller Keith Noreika.  Mr. Noreika has not yet taken any public position with respect to the SPNB charter.  It will not be until the next Comptroller of the Currency is nominated by President Trump, confirmed by the Senate, and takes a position on the SPNB charter that we will be able to realistically assess whether the OCC will continue to pursue the SNPB charter proposal, let alone finalize it.