Since 1863 when Congress passed the National Bank Act, the issue of federal preemption of state law, particularly in respect of interest rates, has generated conflict with the states.  That issue continues to proliferate over 150 years later.  This week, another shot was fired over the bow.

The Attorneys General of 19 states[1] and the District of Columbia (the “AGs”) on June 27, 2018, publicly opposed to previously proposed pieces of legislation pending in Congress often referred to as the “Madden fix” bills.   Namely, the AGs made their views against HR 3299 (“Protecting Consumers’ Access to Credit Act of 2017”) and HR 4439 (“Modernizing Credit Opportunities Act”) in a letter (“AG Letter”) to Majority Leader McConnell, Minority Leader Schumer, Chairman Crapo, and Ranking Member Brown.  A copy of the letter can be found here: AG Letter.  HR 3299 passed the U.S. House of Representatives and is pending in the Senate and revises various laws to state that a loan valid when made does not become invalid when it is sold, transferred or assigned.  HR 4439 pending in a House committee would explicitly state that a bank’s being named lender is not affected by any arrangement is has with a service provider.

By way of background, as previously explained in many published articled and papers, the 2015 decision by the Second Circuit Court of Appeals in Madden v. Midland Funding, LLC precipitated uncertainty among financial services providers and the broader secondary market as the ruling found that a non-bank loan assignee could not enforce the terms of a loan made by a bank when the bank no longer held an interest in the loan.  The consequence was, that some investors did not want to purchase loans made by banks in the Second Circuit (Vermont, Connecticut, and New York) above those states’ usury caps.  Similarly, studies found that prospective borrowers’ access to credit was diminished.

Many legal experts asserted that the decision cast doubt on and generally ignored the longstanding legal principle of “valid-when-made.”  That is, a loan or contract that was non-usurious when it was made remains non-usurious when it is subsequently transferred.  In the Madden case, however, the decision found that the sale and assignment of a loan to a non-bank by a national bank did not transfer to the loan purchaser the right to collect interest at the rate allowed by the national bank and specified in the loan contract.  Critics of the decision (including President Obama’s own US Solicitor General) claim the court’s conclusion is wrong and violates contractual principles of assignment as well as the long standing legal precedent that loans are “valid-when-made.”

The AG Letter asserts that the “Madden” fix bills are not needed and, if passed, “would undermine the states’ ability to enforce our consumer protection laws.”  The AG Letter argues that the bills expand the scope of federal preemption to allow non-banks to circumvent state usury laws.  The letter then goes on to describe a true lender analysis based on economic interests.  Specifically, the letter asserts a concern that the bills will allow behavior that the AGs arguably find as an illicit way to circumvent state usury laws:

 

“Many of these companies contract [sic] with banks to use the banks’ names on loan documents in an attempt to cloak themselves with the banks’ rights to preempt state usury limits. The loans provided pursuant to these agreements are typically funded and immediately purchased by the non-bank lenders, which conduct all marketing, underwriting, and servicing of the loans. The banks do not pay the expenses of the lending program and bear no risk of borrower default. As compensation for their nominal role, the banks receive only a small fee. The lion’s share of profits belong to the non-bank entities that, under these bills, would be exempt from state usury limits.”

 

The AG Letter goes on to support the decision in Madden as in line with previous bank preemption guidance, and the AG Letter cites guidance from the Office of the Comptroller of the Currency – one being the OCC Bulletin 2018-14, Core Lending Principles for Short-Term, Small-Dollar Installment Lending.

It should be noted that the proposed Madden fix bills do not call into question the various CashCall opinions that analyzed true lender theories.  CashCall is an online payday lender extending credit at rates that can reach into the hundred percentiles.  A 2014 West Virginia state court found an arrangement with a South Dakota bank to be wanted and found CashCall to be the true lender of the loans as it held the “predominant economic interest” in the loans.  CashCall has been sued in other cases.  Most notably in 2016 a federal court in California sided with the Consumer Financial Protection Bureau (“CFPB”) in finding that CashCall was the true lender.  In that arrangement, a bank was not involved, rather a Native American tribe.  The loan agreement had the tribe’s law as the governing law of the loans and claimed exemption from usury laws due to sovereign immunity.  Interestingly, despite the CFPB’s requested to award some $300 million in damages the court only awarded a $10 million fine stating that borrowers were not misled about the rates they were being charged for the loans and received the benefit of their bargain.  The CFPB is appealing the damages ruling.

It should also be noted that the OCC guidance noted above was focused on short-term, small-dollar installment lending, loans that are usually payable within two to 12 months and range from $300 to $5,000.  The Cash Call cases similarly focused on short-term, small-dollar lending and found that entities simply cannot “rent-a-charter’ or “rent-a-tribe”; rather, there has to be a true partnership between the bank and the platform providing services to the bank like underwriting, marketing, and servicing.  Click here for an OLPI podcast on this matter.

In the CFPB’s case against CashCall, the CFPB analyzed the true lender factors cited in the AG Letter.  In that case, the CFPB took issue with Western Sky, who was affiliated with the Cheynne River Sioux Tribe to offer loans with annual percentage rates (“APRs”) between 90% to 343%.

The Second Circuit decision in Madden v. Midland did not consider the true lender analysis.

Similar to the AG Letter, certain consumer groups have also voiced concerns about the proposed Madden fix Bills allowing the “rent-a-charter”, concerns highlighted in CashCall as well.  This AG Letter, along with other groups who frame the issue, in light of the pay day lending field ignore other products offered nationally by bank and non-bank partnerships.  Namely, several banks partner with fintech companies,to offer traditional, non-pay-day loans, commonly with terms between 36 and 60 months and APRs less than 36%.  Those programs offered through federally and state regulated banks offer enhanced consumer protection because banking regulators hold the banks responsible for the actions of their service providers and can both regulate and examine the third-party relationships banks have under existing banking guidance.

OLPI believes the following questions and analysis can help interested parties reach a consensus of what these Bills should and should not do:

  • Can states and consumer groups agree on parameters that carve out payday lenders from taking advantage of these Bills – namely, would the rate agreed-to in the Military Lending Act of 36% APR be presumptively non-usurious and in line with legitimate bank vendor partnerships to allow banks the right to export their interest rate?
  • Does the intended effect of the AG’s opposition have un intended and farther-reaching consequences and would the true lender analysis of “predominant economic interest” ensnare other types of loans traditionally subject to third party bank relationships and rattle secondary markets that would restrict the availability of credit, especially to those in need of credit? For example, sales of loans by bank soon after origination are commonplace for retail and auto purchases, credit cards, student loans and most notably mortgage loans.  Most mortgage loans are sold to investors.  Without the Madden fix bills, it is possible that the uncertainty that has been created in both the origination and secondary markets would likely proliferate and endanger long standing practices as the Madden decision has done in the Second Circuit.  Before the alarm bells of the AGs are heeded, practical and long-term effects need to be considered.
  • The century and a half tension between states’ rights and federal preemption may never be eliminated, but Congress must act as the governor to strike the balance between these two competing interests.

 

 

[1] The letter, dated June 27, 2018, is on the letter head of the Office of Attorney General of Colorado and the Office of Attorney General of Massachusetts, and it is signed by the Attorney Generals of Colorado, Massachusetts, California, District of Columbia, Hawaii (Acting, and by the Executive Director of Hawaii Office of Consumer Protection), Illinois, Iowa, Maryland, Minnesota, Mississippi, New Mexico, New York, North Carolina, Oregon, Pennsylvania, Rhode Island, Tennessee, Vermont, Virginia, and Washington State.

Despite the winds of deregulation blowing in Washington, DC, on April 25th the Federal Trade Commission  (FTC) filed suit against the nation’s largest online lender (Lending Club) for allegedly engaging in deceptive practices.

Specifically the FTC cited four areas of concern:  First, the FTC claimed that the online lender prominently stated that it charged “No Hidden Fees” but the origination fee was not disclosed unless the prospective borrower clicked on a small question mark that further explained the annual percentage rate applicable to the loan.  Second, the FTC alleges that borrowers who were told that they were approved for a loan, were subsequently denied the loan which was misleading and unfair.  Third, the FTC claims that unauthorized amounts were withdrawn from deposit accounts such as when loans had been already paid off.  Fourth, the FTC states that the required privacy policy was not delivered in the required manner, it being only a hyperlink on the website terms of use.  The suit, filed in federal court in California seeks customer redress and injunctive relief.  The online lender has denied the allegations and has indicated that some operational issues were corrected upon detection and that in other instances processes have changed.

The online lender issued a press release contesting the allegations made by the FTC as “legally and factually unwarranted.”  See here.  It further explains in a detailed blog post its side of the story and its approach to consumer disclosure at issue in the FTC’s complaint.

This action is a significant development for online lenders at a time when the other federal agency with primary responsibility for consumer financial protection, the CFPB, has seen a change in leadership and significantly curtailed its enforcement activities pending reviews of its policies and procedures.  It is notable that the FTC took action with only two commissioners available to vote on moving forward and it will be interesting to see whether this an isolated case involving a legacy investigation or whether it portends a more activist enforcement mode for the FTC under Trump administration-appointed leadership.  In the meantime, all online lenders would be wise to  evaluate the statements and disclosures made in their advertisements and on their websites to ensure that they are in compliance with applicable laws, especially laws prohibiting unfair and deceptive acts and practices such as the Federal Trade Commission Act and similar state laws.

News Flash: Colorado versus Fintech Update — Magistrate remands Avant

The Grinch came a few days early in Colorado.  A U.S. magistrate judge made a recommendation to the District Court to remand back to state court the pending action filed by the state of Colorado against a marketplace lender based on true lender issues.  The crux of the decision is that, since no bank was a party to the action, there is no basis to exercise federal subject matter jurisdiction.  Objections may be filed with respect to the recommendation and the U.S. District Court is not bound to follow the recommendation or could choose to modify it.  Banks making marketplace loans have filed actions in federal court in Colorado that remain pending.

OLPI believes how the judge framed this issue may be misguided and will fuel inflated concerns about marketplace lending business models.  While the crux of the decision is that an FDIC insured bank was not named in the action, the magistrate judge makes broad factual and legal observations related to a true lender analysis that does not have any real legal precedential value but will no-doubt precipitate a flood of articles from law firms and otherwise rile investor sentiment.  OLPI has already observed that investors in marketplace loans have already grown wary of Colorado loans –as such, the “broad observations” and other actions in the state of Colorado appear to be limiting credit to Colorado citizens from marketplace lenders.  This fact may play into and strengthen the WebBank and Cross River Bank actions that are currently pending in federal courts and discussed here.

The Federal Reserve Bank of Cleveland’s recent study on P2P lending raises several serious issues concerning the use of proceeds for online loans and the result of marketplace lending. Specifically, the study highlights concerns related to use of proceeds for online loans, results of lending in terms of credit scores, and overall financial impact on borrowers.

The Online Lending Policy Institute (OLPI) looks forward to discussing this study with its authors, as well as reviewing the P2P lending study with the authors of a separate study by the Federal Reserve Bank of Philadelphia, which reached markedly different conclusions.

OLPI notes, however, that the Cleveland Fed’s study makes an unfortunate comparison between online lending and the subprime loans leading up to the Financial Crisis. There is no apt comparison between online lending and subprime lending preceding global financial crisis, and rhetorical flourishes such as this undermine serious research related to online lending that is both merited and necessary.

Similarly, the study’s concluding observation that “… there are no regulators that oversee the online lending marketplace and its players” is false and misleading. Online lending is subject to a wide array of federal and state consumer protection laws and regulations as detailed here.

Data Breach. Yesterday, Equifax revealed that it incurred a massive data breach – impacting at least 143 million consumers. Equifax is reaching out to all of its clients – including many online lenders – to let them know what it is doing to mitigate the effects of this massive breach. Equifax’s official statement is that they are ensuring a breach like this never happens again, none of their core credit databases were penetrated, and they plan to offer every U.S. consumer free credit monitoring for a specified period of time.

What’s Next? There are already news reports that Equifax may not be handling the influx of concerned consumers well – requiring consumers to enter their last name and last six digits of their Social Security number (which has irked more than a few consumers). Interestingly, this request for “last six digits” seems to indicate that the typical requirement for last four is not enough to verify consumers’ identities after this breach.

Equifax, however, is doing the right thing by actively reaching out to their clients and consumers.  They have assured their clients that the breach related only to their consumer facing site and not to their core credit database, so consumers’ credit reports (detailing tradelines, etc.) were not exposed.

Lender Implications. Today, online lenders will review their third-party risk management protocols to better understand the nature of the breach and to develop a response to their impacted clients. Tomorrow, online lenders will have to get some comfort that Equifax has sufficiently handled this problem and, as they are handling this problem, online lenders need to ensure that Equifax is still able to handle other aspects of its relationship with these clients. Namely, Equifax has a large suite of fraud prevention products that the online lending industry relies on, among other related services.

Also of note, the long term effects of this breach may impact the integrity of the data that online lenders use for a variety of reasons (target marketing and prescreened offers, underwriting and pricing for instance).  If that impact is negative, it could hurt the operations of the online lenders and could also result in more fraud due to the speed of the process – online lenders will need to show how their security accounts for these highlighted risks.

OLPI will continue to monitor this story as it develops.  OLPI will also ensure that this issue – cyber security risks—is fully briefed at its 2nd Annual OLPI Policy Summit this month on September 25 in Washington, DC. For more information, please visit http://www.onlinelendingpolicysummit.com/

The 2015 decision by the Second Circuit Court of Appeals in Madden v. Midland Funding, LLC precipitated uncertainty among financial services providers and the secondary market.  Many legal experts believed the decision cast doubt on and generally ignored the longstanding legal principle of “valid-when-made.”  That is, a loan or contract that was non-usurious when it was made remain non-usurious when it is subsequently transferred to another person.  In Madden, however, the decision found that the sale and assignment of a loan to a non-bank by a national bank did not necessarily transfer to the loan purchaser the right to charge interest at the rate allowed by the national bank and specified in the loan contract.  Critics of the decision (including President Obama’s US Solicitor General) claim the court’s conclusion is wrong and violates contractual principles of assignment as well as the long standing legal precedent that loans are “valid-when-made.” Read More

Comptroller Curry will leave his post as Comptroller of the Currency on May 5.  President Trump appointed Keith Noreika to serve as acting comptroller.  Mr. Noreika is a banking law expert and a partner at the law firm of Simpson Thacher & Bartlett LLP.  He will keep the OCC running until President Trump names a permanent replacement (and that proposed permanent replacement is confirmed by the Senate). Read More

The State of Colorado is challenging the marketplace lending model.  On February 15, 2017,  the Administrator of the Uniform Consumer Credit Code for the State of Colorado (“Colorado”) sued Avant and Best Egg (in separate actions), claiming in both actions that they violated Colorado’s usury rate and entered into loan agreements containing a governing law provision other than Colorado.  Click here to see the Complaint against Avant and hereto the see the Complaint against Best Egg.  Colorado sued Avant and Best Egg, but did not sue their partner banks, WebBank and Cross River, respectively.  The Complaints allege that Avant and Best Egg are the true lenders. Read More

States have taken their dislike over the OCC’s planned fintech charter a step further and sued the OCC in the US District Court for the District of Columbia.  The Conference of State Bank Supervisors sued the OCC and Comptroller Curry arguing, among other things, that the “business of banking” requires an institution to take deposits.  Strangely, this ignores existing national bank models: credit card banks, trust banks, and cash management banks.  All of this being said, CSBS also argues that the OCC violated the Administrative Procedure Act by publishing only a high-level white paper and supplement to the Comptroller’s Licensing Manual (which they did seek feedback on) — thereby avoiding publishing new rules that welcome the public vetting process.  This argument will likely have more teeth.

Read the Complaint here: 2017-04-26 – Complaint – CSBS v. OCC