By: Jeremy M. Creelan, Megan B. Poetzel, Jenna E. Ross, and Karolina L. Bartosik

The regulation and enforcement of financial technology (Fintech) remains in sharp focus for California’s consumer finance regulator, the Department of Financial Protection and Innovation (DFPI), as it moves into its second year of operation. This Alert provides a short overview of the DFPI’s origins, a comparison of the DFPI’s stated priorities with its regulatory activities in its inaugural year, and an analysis of recent enforcement actions relevant to Fintech.   

Background

In August 2020, the California legislature passed Assembly Bill 1864, which included the California Consumer Financial Protection Law (CCFPL), one of the most expansive consumer protection laws in the country, and replaced the Department of Business Oversight (DBO) with the DFPI. As discussed in a contemporaneous blog post in Jenner & Block’s Consumer Law Round-Up, the CCFPL charges the DFPI with regulating “the provision of various consumer financial products and services” and exercising “nonexclusive oversight and enforcement authority under California and federal (to the extent permissible) consumer financial laws.”

To meet its “dual mission to protect consumers and foster responsible innovation,” the CCFPL expanded the scope of the DFPI’s oversight authority powers to cover entities and products not previously regulated by DBO, although it exempted major financial institutions from its reach. The DFPI now oversees nonbank small business lenders and Fintech companies, along with debt relief companies, consumer credit reporting agencies, among others, and can investigate and sanction unlawful, unfair, deceptive, or abusive acts or practices by any person offering or providing consumer financial products or services in the state. The CCFPL also grants the DFPI “the power to bring administrative and civil actions, issue subpoenas, promulgate regulations, hold hearings, issue publications, conduct investigations, and implement outreach and education programs.”

A Comparison of the DFPI’s Stated Priorities with its 2021 Activities

In its first monthly bulletin after the implementation of the CCFPL, the DFPI announced three notable areas of interest. Over a year later, in March 2022, the DFPI published a report summarizing its 2021 activities. A comparison of the two reveals areas of progress and sustained focus.

First, the DFPI promised to “review and investigate consumer complaints against previously unregulated financial products and services, including debt collectors, credit repair and consumer credit reporting agencies, debt relief companies, rent to own contractors, private school financing, and more.” In its annual report, the DFPI reported that it has collected “close to $1 million in restitution for consumers from enforcement actions” and reviewed 30% more complaints in 2021 than in 2020.  Notably, “[t]he top categories of [consumer] complaints included debt collection, cryptocurrency, and ‘neo banks’ (fintech companies partnering with banks to offer deposit account services).”

Second, the DFPI prepared to open the Office of Financial Technology Innovation, made “to work proactively with entrepreneurs and create a regulatory framework for responsible, emerging financial products.” Almost immediately, the DFPI signaled its interest in regulating earned wage access (EWA), or the ability for employees to access their wages before their scheduled payday. Not long after publication of its monthly bulletin, the DFPI entered into memoranda of understanding (MOU) with five EWA companies. The companies agreed to deliver quarterly reports beginning in April 2021 “on several metrics intended to provide the [DFPI] with a better understanding of the products and services offered and the risk and benefits to California consumers.” Later, the DFPI signed six additional MOU with EWA companies and stated in its annual report that the quarterly reports required in the MOU will “inform future oversight efforts.” The DFPI also indicated potential rulemaking may be forthcoming related to wage-based advances, including the registration of covered persons, record retention, and reporting.

Third, the DFPI stated that it would create the Division of Consumer Financial Protection, which would “feature a market monitoring and research arm to keep up with emerging financial products.” Per its report, the DFPI created a research team in September 2021, which is “in the process of evaluating DFPI’s consumer complaint data to identify broader market trends that may pose risks to consumers.”

Key Areas of DFPI Enforcement Related to Fintech

The Fintech industry has been a focus of DFPI enforcement activity since its inception. In one early action, for instance, the DFPI entered a desist and refrain order against a Fintech platform for allegedly selling securities, including cryptocurrency, without a broker-dealer certificate; misleading consumers in the sale of the securities; and engaging in unlicensed securities transactions.

In the last few months, the DFPI has continued to provide guidance to the industry in a variety of areas, via interpretive opinions and enforcement actions. Companies providing similar financial products and services in California should take note.

• “True lender” and interest rate caps
  • In December 2021, the DFPI entered a consent order with a California company that had marketed consumer loans to California borrowers with interest rates in excess of the maximum set by California law. In the consent order, the company agreed not to market or service loans of less than $10,000 with interest rates greater than those set by the California Fair Access to Credit Act. The entrance of the consent order reveals that the DFPI viewed the California company as the true finance lender under the California Financing Law and the CCFPL, even though the company did not fund the loans and had provided servicing and marketing services to its banking partner, a Utah bank that is exempt from California’s usury laws.
  • In reaction to the above order, a Fintech platform and nondepository that operates a similar bank partnership program filed suit against the DFPI in March 2022, seeking a declaration that California’s interest rate caps do not apply to its loan program because its Utah bank partner originates and funds the loans. In April 2022, the DFPI filed a cross-complaint, accusing the Fintech platform of deceptive and unlawful business practices, by engaging in a “rent-a-bank” partnership scheme that allows it to evade California interest rate caps and promote predatory lending practices. The cross-complaint alleges that the Fintech platform is the “true lender” of the loans because it has the predominant economic interest in the transaction, as it collects nearly all of the loan profits after purchasing the loans’ receivables within days of their funding, shielding its bank partner from any credit risk. The DFPI also alleges that the Fintech platform performs traditional lender roles in marketing, underwriting, and servicing the loans. The DFPI seeks at least $100 million in penalties, in addition to restitution to the affected borrowers.
• Wage-based advances and lender licensing
  • In a February 2022 interpretive opinion, the DFPI concluded that certain employer-facilitated advances, for which an EWA provider contracts with an employer to offer its employees early access to wages, were not loans under either the California Financing Law, which regulates consumer credit, or the California Deferred Deposit Transaction Law, which regulates payday loans. In reaching this conclusion, the DFPI found that the source of the funding (the employer), the limit on the funding amount (to the amount an employee earned), and the nominal fees associated with the advance counseled against the application of California’s lending laws. Therefore, the inquiring EWA provider and its employer-partner were not required to obtain lending licenses.
  • By contrast, the DFPI alleged in two recent enforcement actions that a merchant cash agreement (providing funding in exchange for a percentage of a company’s future revenue) and an income share agreement (providing college tuition funding in exchange for a percentage of the student’s income after graduation) qualify as loans, and such providers must be licensed in accordance with applicable California law.
• Cryptocurrency and digital asset trading
  • In a March 2022 interpretive opinion, the DFPI addressed whether the California Money Transmission Act (MTA), which prohibits unlicensed engagement in the business of money transmission in the state, applies to software that provides retail and institutional investors with the ability to buy, sell, and store cryptocurrency. Of note, the MTA defines “money transmission” to include the selling or issuing of “stored value”; the selling or issuing of payment instruments; and the receipt of money for transmission. The DFPI concluded that closed-loop transactions, where the company does not facilitate the exchange of cryptocurrency transactions with a third party and the customer can only redeem monetary value stored in the account for cryptocurrency sold by the company, do not meet the definition of “money transmission.” However, the DFPI explained that it has not determined whether a “wallet storing cryptocurrency” is a form of “stored value” under the MTA.  Accordingly, the DFPI did not require the inquiring platform to be licensed in order to provide customers with fiat and digital wallets to store and exchange cryptocurrency directly with the platform. The DFPI noted, however, that the licensing requirements remain subject to change.
  • A month earlier, the DFPI concluded in a February 2022 consent order that sales of a cryptocurrency retail lending product qualify as a security under California law. Specifically, the company at issue offered and sold interest-bearing digital asset accounts, “through which investors could lend digital assets to [the company] and in exchange, receive interest” paid in cryptocurrency. The DFPI concluded that these accounts are securities, and that the company had wrongfully engaged in unregistered securities transactions. The DFPI’s decision came shortly after the federal Securities and Exchange Commission charged the company with a similar violation of federal securities laws, finding that the accounts were both “notes” and “investment contracts” because the investors’ digital assets were pooled and packaged as loan products that generated returns for the company and yielded variable monthly interest payments contingent on the company’s deployment and management of the assets.

As this overview makes clear, Fintech remains a top priority for the DFPI’s regulatory and enforcement activity in 2022. Jenner & Block will continue to monitor the DFPI and report on the dynamic regulatory landscape affecting Fintechs.

By: Jenna L. Conwisar

Payday loans are small-dollar cash loans typically due in a single payment on the borrower’s next payday—they are extremely short-term and generally high-interest forms of consumer credit.[1] If the borrower cannot pay off the loan when it’s due, some states allow the borrower to pay a fee to defer full payment on, or “rollover,” their loan. A 2014 Consumer Financial Protection Bureau (CFPB) report found that over 80% of payday loans are rolled over within two weeks.[2]

The CFPB notes that upwards of 12 million borrowers utilize payday loans each year.[3] 16 states now require that payday lenders allow borrowers to repay their payday loans at regular intervals through Extended Payment Plans, or EPPs, typically at no additional cost to the borrower.[4]

On April 6, 2022, the CFPB published a report examining state EPPs.[5] Below are some of the CFPB report’s key findings.

Variation and Commonality Among State EPP Laws

The CFPB report found “substantial variation” among state EPPs, particularly in consumer eligibility requirements.[6] Depending on the state they are borrowing in, consumers may become EPP-eligible after surpassing a set number of rollovers, after they pay a certain percentage of the outstanding balance, or after they enroll in credit counseling.

Most states require EPPs to include at least four equal or substantially equal installments, and consumers are typically limited to one EPP election in a 12-month period. Many states mandate that lenders disclose the availability of an EPP option to consumers at the time they enter into the payday loan agreement or at the time of default.

EPP Usage, Default, and Rollover Rates

According to the CFPB report, extended payment plan usage rates vary drastically across states, with Washington reporting that 13.4% of payday loans converted to EPPs in 2020 compared to Florida’s 0.4%. In California, EPP usage rates doubled from 1.2% in 2019 to 3.0% in 2020. While the COVID-19 pandemic saw payday loan volume decrease by 65%, EPP usage rates tended to rise slightly. The report attributes the decline in overall payday loan volume to the federal Economic Impact Payments.

Meanwhile, rollover and default rates still remain higher than EPP usage rates. For example, 27% of Washington payday borrowers defaulted on their loan in 2020 and 47.1% of Idaho borrowers rolled over their loan in 2016. The CFPB attributes these high rates to lenders implementing practices that discourage EPP use. In the report’s press release, CFPB Director Rohit Chopra acknowledged that “[p]ayday lenders have a powerful incentive to protect their revenue by steering borrowers into costly re-borrowing” causing “state laws that require payday lenders to offer no-cost extended repayment plans [to] not work[] as intended.”[7]

*          *          *

Imbedded throughout the report is the CFPB’s clear preference for expanded EPP opportunities in order to prevent consumers from amassing repeat rollover fees. In 2014, the CFPB reported that most borrowers rollover their payday loans enough times that the accumulated rollover fees exceed the original loan amount.[8] Lenders should take note that the CFPB “will continue to monitor lender practices that discourage consumers from taking extended payment plans and take action as necessary.”[9]

[1] Payday loans are legal in only 26 states: Alabama, Alaska, California, Delaware, Florida, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Michigan, Minnesota, Mississippi, Missouri, Nevada, North Dakota, Rhode Island, South Carolina, Tennessee, Texas, Utah, Washington, Wisconsin, and Wyoming.

[2] CFPB Finds Four Out Of Five Payday Loans Are Rolled Over Or Renewed, CFPB (Mar 25, 2014).

[3] CFPB Finds Payday Borrowers Continue to Pay Significant Rollover Fees Despite State-Level Protections and Payment Plans, CFPB (Apr 6, 2022).

[4] Alabama, Alaska, California, Delaware, Florida, Idaho, Indiana, Louisiana, Michigan, Nevada, South Carolina, Utah, Washington, Wisconsin, and Wyoming.

[5] Market Snapshot: Consumer Use of State Payday Loan Extended Payment Plans, Consumer Financial Protection Bureau (April 2022).

[6] Id. at 5, 7.

[7] CFPB Finds Payday Borrowers Continue to Pay Significant Rollover Fees Despite State-Level Protections and Payment Plans, supra note 3.

[8] CFPB Data Point: Payday Lending, CFPB (March 2014).

[9] Market Snapshot, supra note 5, at 14.

By: Laura P. MacDonald, Elizabeth A. Edmondson, and Adina Hemley-Bronstein

On March 31, 2022, the US Supreme Court issued a significant decision in Badgerow v. Walters, No. 20-1143, ending a circuit split about when federal courts have subject matter jurisdiction to review domestic arbitration awards under the Federal Arbitration Act (FAA). In an 8-1 opinion, the Court ruled that federal courts cannot “look through” to the underlying controversy to establish subject matter jurisdiction to confirm or vacate an arbitral award under the FAA. As a result, absent diversity of citizenship, petitioners seeking to confirm or vacate domestic arbitration awards under the FAA must now bring those petitions in state court.

The FAA governs the enforcement of most arbitration agreements in the United States. The statute dictates the standards for compelling arbitration (under Section 4) and for the confirmation or vacatur of an arbitration award (under Sections 9 and 10). But, although the FAA authorizes a party to make these petitions, the statute does not automatically authorize federal courts to hear them. This is because the FAA, unlike almost all federal statutes, does not itself confer federal subject matter jurisdiction, at least for domestic arbitration agreements. Instead, for a federal court to decide a petition under the FAA, the court must have an “independent jurisdictional basis.” Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 582 (2008). (Section 2 of the FAA confers federal subject matter jurisdiction over “non-domestic arbitrations,” i.e., those that have at least one foreign party or a substantial international nexus.)

The issue before the Court in Badgerow was whether a federal court may determine its jurisdiction to confirm or vacate an arbitration award only by looking at the face of the petition for judicial review, or whether it may “look through” the petition and examine whether federal jurisdiction would exist over the underlying dispute. The Court had previously authorized look-through jurisdiction in the context of petitions to compel arbitration under Section 4 of the FAA, see Vaden v. Discover Bank, 556 U.S. 49 (2009), but a circuit split had emerged regarding whether the same approach applied to petitions to confirm or vacate under Sections 9 and 10. Whereas the Third and Seventh Circuits maintained that Vaden should be confined to petitions to compel under Section 4, the Second Circuit, along with the First and Fourth, applied look-through jurisdiction to other petitions brought under the FAA. This means that until now, the Second Circuit has permitted federal court access for many petitioners seeking review of arbitration awards in New York, where a significant number of the nation’s arbitrations take place.

The case arose from an employment arbitration. The petitioner Denise Badgerow brought state and federal claims against her former employer for unlawful termination. After the arbitrators dismissed her claims, Badgerow filed suit in Louisiana state court to vacate the decision, arguing that fraud had taken place during the arbitration proceeding. In response, Badgerow’s employer removed the action to federal district court and petitioned the court to confirm the arbitration award. Badgerow then moved to remand, arguing that the federal district court lacked the subject matter jurisdiction needed to confirm or vacate the award under Sections 9 and 10 of the FAA. The district court applied Vaden’s look-through approach and held that, because the underlying employment dispute involved federal-law claims, it could therefore exercise jurisdiction over the employer’s petition to review and confirm the award. The Fifth Circuit affirmed, joining the First, Second, and Fourth Circuits in extending the look-through approach to additional petitions under the FAA.

On appeal, the Supreme Court reversed. Resolving the existing circuit split, it held that the look-through approach applicable under Section 4 does not apply to petitions to confirm or vacate arbitration awards under Sections 9 and 10. Thus, jurisdiction to confirm or vacate an arbitration award must be apparent on the face of the petition itself and independent of the underlying dispute. The Court reasoned that Sections 9 and 10 “contain none of the statutory language on which Vaden relied” and “[m]ost notably” lacked “Section 4’s ‘save for’ clause.” Unlike Section 4, Sections 9 and 10 “do not instruct a court to imagine a world without an arbitration agreement, and to ask whether it would then have jurisdiction over the parties dispute.” In fact, the Court pointed out, “Sections 9 and 10 do not mention the court’s subject-matter jurisdiction at all.” Applying standard principles of statutory interpretation, the Court reasoned that while “Congress could have replicated Section 4’s look-through instructions in Sections 9 and 10,” it did not, leading to the Court’s conclusion that federal courts may determine their jurisdiction only by assessing the parties’ petitions to confirm or vacate and not by looking through to the underlying controversy.

Following Badgerow, parties seeking to confirm or challenge arbitration awards in federal court will need to show that a federal question exists on the face of the petition itself. In practice, parties will have to show that either (a) the arbitration agreement is “non-domestic” and thus eligible for federal jurisdiction under Section 2, (b) federal diversity jurisdiction exists over the dispute, or (c) the confirmation action receives pendent jurisdiction due to the presence of a separate and independent federal claim.

The Court’s decision in Badgerow will likely shift a substantial number of confirmation and vacatur actions to state courts. While the FAA will remain the governing law, the shift to state court will require practitioners to follow state procedural rules and will potentially introduce questions about how state arbitration law can fill any gaps in the FAA itself.

By: Michael W. Ross, Ali M. Arain, and Jonathan S. Steinberg

On March 16, 2022, the Consumer Financial Protection Bureau (CFPB) announced its intent to address discrimination as an “unfair practice” under the Consumer Financial Protection Act (commonly known as Dodd-Frank). Specifically, by indicating that discrimination falls within “unfair practices” in its Exam Manual, the CFPB has authorized its examiners to look “beyond discrimination directly connected to fair lending laws” and ask companies to “review any policies or practices that exclude individuals from products and services, or offer products or services with different terms, in an unfairly discriminatory manner.”^[1]

Utilizing the Bureau’s manual, CFPB Examiners play a critical role in evaluating companies’ compliance with Dodd-Frank and other federal consumer protection laws in addition to aiding in the determination of whether “supervisory or enforcement actions are appropriate.”^[2]

In its efforts to combat discrimination, the CFPB is particularly concerned with the growing use of artificial intelligence and machine learning, and how consumers from protected classes may be uniquely harmed by biased algorithms. For example, “data harvesting and consumer surveillance fuel complex algorithms that can target highly specific demographics of consumers to exploit perceived vulnerabilities and strengthen structural inequities.”^[3]

Dodd-Frank prohibits “any provider of consumer financial products or services” from engaging in unfair, deceptive and abusive acts and practices (UDAAP).^[4] It further provides the CFPB with “enforcement authority to prevent unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.”^[5] In addition, Dodd-Frank provides the CFPB with “supervisory authority for detecting and assessing risks to consumers and to markets for consumer financial products and services.”^[6] In this capacity, the CFPB maintains “supervisory authority over banks, thrifts, and credit unions with assets over $10 billion, as well as their affiliates [and] . . . nonbank mortgage originators and servicers, payday lenders, and private student lenders of all sizes.”^[7]

Under Dodd-Frank, “an act or practice is unfair when:

• It causes or is likely to cause substantial injury to consumers;
• The injury is not reasonably avoidable by consumers; and
• The injury is not outweighed by countervailing benefits to consumers or to competition.”^[8]

The CFPB, in its updated manual, details how it contends discrimination satisfies this definition. First, regarding the likelihood of “substantial injury,” the manual points to “[f]oregone monetary benefits or denial of access to products or services” that can result from discrimination.^[9] Critically, the CFPB notes that “[c]onsumers can be harmed by discrimination regardless of whether it is intentional.”^[10] Next, concerning reasonable avoidability, the CFPB states that the question is not “whether a consumer could have made a better choice[,]” but rather “whether an act or practice hinders a consumer’s decision-making.”^[11] To that end, the CFPB contends that “[c]onsumers cannot reasonably avoid discrimination.”^[12] Finally, the CFPB’s press release notes that “discrimination may meet the criteria for ‘unfairness’ . . . where that harm is not outweighed by countervailing benefits to consumers or competition.”^[13]

While the manual’s updated language does not create legal duties, such as those imposed by fair lending laws, it establishes the CFPB’s expectations for covered entities. For this reason, these changes to the manual will likely have a substantial real-world impact on companies that engage in consumer-related financial transactions.

[1] Eric Halperin & Lorelei Salas, Cracking Down on Discrimination in the Financial Sector, Consumer Fin. Prot. Bureau (Mar. 16, 2022), https://www.consumerfinance.gov/about-us/blog/cracking-down-on-discrimination-in-the-financial-sector/.

[2] Consumer Fin. Prot. Bureau, CFPB Supervision and Examination Manual, 11 (March 2022) https://www.cfpaguide.com/portalresource/Exam%20Manual%20v%202%20-%20UDAAP.pdf (Examination Manual).

[3] Halperin & Salas, supra note 1.

[4] Press Release, Consumer Fin. Prot. Bureau, CFPB Targets Unfair Discrimination in Consumer Finance (Mar. 16, 2022), https://www.consumerfinance.gov/about-us/newsroom/cfpb-targets-unfair-discrimination-in-consumer-finance/.

[5] Examination Manual, supra note 2, at 1.

[6] Id. at 1.

[7] Consumer Fin. Prot. Bureau, Institutions Subject to CFPB Supervisory Authority, https://www.consumerfinance.gov/compliance/supervision-examinations/institutions/ (last visited Mar. 28, 2022).

[8] Examination Manual, supra note 2, at 1–2. This is the same test applied by the FTC under the FTC Act.

[9] Examination Manual, supra note 2, at 2.

[10] Press Release, Consumer Fin. Prot. Bureau, supra note 4.

[11] Examination Manual, supra note 2, at 2.

[12] Id. at 2.

[13] Press Release, Consumer Fin. Prot. Bureau, supra note 4.