FinTech Feed

The Wait is Over: FDIC Approves Insurance for New Industrial Banks for the First Time in Over a Decade

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By: Susanna D. Evarts

New UpdateOn March 18, 2020, the Federal Deposit Insurance Corporation (FDIC) approved the deposit insurance applications for industrial bank applicants Square, Inc., a provider of payment services for small businesses, and Nelnet, Inc., a student loan servicer.  The approvals allow Square and Nelnet to create new industrial banks chartered under Utah law.  Obtaining an industrial bank charter allows companies that are not bank holding companies to own banks that are authorized to originate consumer and commercial loans and collect insured deposits.  Square and Nelnet’s applications are the first that the FDIC has approved in over a decade, marking a potentially significant shift in how the FDIC will treat such applications, and reflecting an increase in the number of active Utah industrial banks, which has hovered at fifteen.  These state-chartered financial institutions are generally subject to the same banking laws and regulations as other types of bank charters.

The approvals come one day after the FDIC issued a proposed rule for public comment, which would impose certain conditions on industrial bank applicants.  This marks a change in the FDIC’s position on approving deposit insurance applications for industrial banks, indicating that the long-dormant industrial bank charter may begin to attract attention once more.  The two new approvals and proposed rule may prompt FinTech and other tech companies to consider seeking a charter as a way to expand their market presence.


OCC and FDIC Propose “Madden Fix” Rules to Codify “Valid-When-Made” Principle

By: William S. C. Goldstein

New-Development-IconThe long-running saga of Madden v. Midland Funding is entering a new phase.  Last week, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) proposed rules that would codify the concept that the validity of the interest rate on national and state-chartered bank loans is not affected by the subsequent “sale, assignment, or other transfer of the loan.” See Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 84 Fed. Reg. 64229, (proposed Nov. 18, 2019); FDIC Notice of Proposed Rulemaking, Federal Interest Rate Authority, FDIC (proposed Nov. 19, 2019).  Under these rules, an interest rate that is validly within any usury limit for such a bank when it is made would not become usurious if the loan is later transferred to a non-bank party that could not have charged that rate in the first instance.

The proposed rules are a long-awaited response to the Second Circuit’s decision in Madden, which held that a non-bank purchaser of bank-originated credit card debt was subject to New York State’s usury laws.  786 F.3d 246, 250-51 (2d Cir. 2015).  In so holding, the Second Circuit cast doubt on the scope of National Bank Act (NBA) preemption, which exempts national banks from most state and local regulation, allowing them to “export” their home state interest rates without running afoul of less favorable usury caps in other states (FDIC-insured state banks are afforded similar protections).  Before Madden, it was widely assumed that “a bank’s well-established authority [under the NBA] to assign a loan” included the power to transfer that loan’s interest rate.  See Permissible Interest on Loans That Are Sold, 84 Fed. Reg. at 64231. The Madden decision also did not analyze the “valid-when-made” rule, a common law principle providing that a loan that is non-usurious at inception cannot become usurious when it is sold or transferred to a third party. See, e.g., Nichols v. Fearson, 32 U.S. (7 Pet.) 103, 109 (1833) (“[A] contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent usurious transaction.”).  Madden has been widely criticized by a host of commentators, including the Office of the Solicitor General.

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Texas Jury Awards $200 Million In Mobile Banking Patent Dispute

By: Benjamin J. Bradford IStock-1155413889

On November 6, a jury in the Eastern District of Texas awarded the United Services Automobile Association (USAA) a $200 million verdict finding that Wells Fargo willfully infringed two of USAA’s patents directed to the “auto-capture” process, which is used by banking customers to deposit checks using photographs taken from a mobile phone or other device.  (Civ. No. 2:18-cv-00245 (E.D. Tex.))  Based on the finding of willfulness, USAA may be entitled to enhanced damages beyond the $200 million verdict.

Despite the verdict, the fight between Wells Fargo and USAA is still ongoing.  Wells Fargo filed patent office challenges to the validity of USAA’s patents, which are still pending before the Patent Trial and Appeals Board, but may not be decided for another 15 months.  In addition, Wells Fargo will likely appeal the decision, including a recent denial of summary judgment that found the patents were not invalid under 35 U.S.C. 101.  Nevertheless, the verdict against Wells Fargo will likely embolden USAA to assert its patents against other banks and financial institutions that use an “auto-capture” process. 


DC Court Again Dismisses Challenge to OCC’s FinTech Charter, Splitting with SDNY

By: William S. C. Goldstein

FinTechOn September 3, 2019, a federal district court in the District of Columbia dismissed, for the second time, a lawsuit brought by the Conference of State Bank Supervisors (CSBS) seeking to block the Office of the Comptroller of the Currency (OCC) from issuing national bank charters to certain non-bank financial technology (FinTech) companies.  Conference of State Bank Supervisors v. Office of the Comptroller of the Currency, No. 18-cv-2449, slip op. at 1-6 (D.D.C. Sept. 3, 2019) (CSBS II).  CSBS’s earlier suit, brought in 2017, was previously dismissed by Judge Dabney Friedrich as premature:  Because OCC had not yet finalized its procedure for accepting FinTech charter applications, let alone received any applications, Judge Friedrich found that CSBS’s claims were unripe and alleged no injury sufficient for standing.  CSBS v. OCC, 313 F. Supp. 3d 285, 296-301 (D.D.C. 2018).  In October 2018, CSBS brought suit again—this time after OCC had finalized its procedures for accepting FinTech charter applications, albeit before OCC had actually received any applications.  CSBS II, slip op. at 2.  Judge Friedrich held that neither this change nor the Senate’s confirmation of Joseph Otting as Comptroller of the Currency, another change in the facts highlighted by CSBS, “cure[s] the original jurisdictional deficiency.” Id. (alteration in original; citation omitted).  The court pointedly explained that “it will lack jurisdiction over CSBS’s claims at least until a Fintech applies for a charter.” Id. at 5.

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Regulators Continue to Focus on the Use of Alternative Data

By: Michael W. Ross

Consumer Law Blog - August 2019In an article published last month in Law360 (and reprinted in our Consumer Finance Observer periodical), our lawyers highlighted the increasing focus of government enforcement authorities on how companies are using “alternative data” in making consumer credit decisions. For example, the article highlighted that – as stated in a June 2019 fair lending report from the CFPB – “[t]he use of alternative data and modeling techniques may expand access to credit or lower credit cost and, at the same time, present fair lending risks.” Regulators have continued to focus on this area, including on the benefits and risks of using alternative data in lending decisions.

Earlier this month, the CFPB posted a widely reported-on blog entry on the benefits of using alternative data in lending decisions. The CFPB blog post provided an update to the public on the agency’s first and only no-action letter, issued to Upstart Network, Inc. in 2017. In that letter, the CFPB stated it had no intention of taking action against Upstart under the Equal Credit Opportunity Act (ECOA), which prohibits discrimination in lending, for using certain alternative data sources – particularly information about a borrower’s education and employment history – to make credit decisions. To obtain that letter, Upstart committed to implementing a risk management and compliance plan that included a process for analyzing the potential risk that its use of alternative data could lead to impermissible discrimination against protected classes of consumers.

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Crypto Corner – Updates on Cryptocurrency

By: Michael W. Ross

CryptoIn the first half of 2019, the “crypto-winter” that had set in during 2018 appeared to see signs of a thaw, albeit with new regulatory developments and controversy continuing to characterize the space.  On the regulatory front, the Securities and Exchange Commission (SEC) issued more detailed guidelines for companies seeking to sell digital tokens.  The 13-page “Framework for ‘Investment Contract’ Analysis of Digital Assets” provides a detailed analysis of the factors relevant to the Howey test that the SEC uses to determine the existence of a security (and all that designation entails).  At the same time, the SEC issued a no-action letter for a company that had represented it would not be using its tokens to fund the development of the token network, and that the tokens would be immediately usable—underscoring two key factors of the SEC’s assessment.  In another development, the Financial Action Task Force (FATF)—a global inter-governmental organization focused on fighting money-laundering—issued new guidelines on cryptocurrency companies operating in its 37 member countries, including requirements about collecting user information.  FINRA has also decided to continue a reporting initiative it announced last year.

On the news-making front, much industry attention was paid to the SEC’s suit against a Canadian messaging company called Kik Interactive, alleging that Kik propped up its failing business by pivoting to an unregistered token offering through which it raised $100 million.  Some have viewed the case as one to watch to see whether courts will view digital tokens the same way as the SEC has.  More recently, focus on developments at the SEC have been overtaken by news of Facebook’s anticipated Libra token.  Built on a permissioned blockchain network overseen by a litany of household names, and backed by a basket of traditional assets, the Libra token met early news of its potential to change the game for cryptocurrency.  More recent weeks have seen a flurry of commentary by regulators and legislators focused on the need to analyze the token under existing financial services laws, as well as concerns about money-laundering, consumer protection and privacy.  For those interested in the space, it will be worth monitoring further developments as they unfold.

 


Facebook’s Libra Prompts Federal Draft Legislation

 

By: Jeffrey A. Atteberry

CryptocurrencyIn June, Facebook publicly launched an initiative to develop a cryptocurrency called Libra in partnership with 27 other technology and finance companies including Visa, PayPal and Uber.  According to Facebook, consumers will be able to buy Libra anonymously and then use the currency to buy things online, send money to people, or cash out at physical exchange points such as grocery stores.  The blockchain technology behind Libra is meant to be open-source and not controlled exclusively by Facebook, but by an association of its founding companies, each of which has already invested at least $10 million into the venture. 

Facebook’s announcement triggered a rapid response from federal legislators, and on July 15 the House Financial Services Committee introduced draft legislation aimed at preventing large tech companies from creating digital currencies such as Libra.  Entitled “Keep Big Tech Out of Finance Act,” the draft legislation would apply only to tech companies with over $25 billion in annual global revenue that primarily operate online marketplaces or social platforms.  Such companies would be prohibited from using blockchain or distributed ledger technology to create or operate “a digital asset that is intended to be widely used as a medium of exchange, unit of account, store of value, or any other similar function.”  The draft legislation would further prohibit such tech companies from being or affiliating with “a financial institution.” 

The draft legislation is just the latest indication that federal legislators and regulators are increasingly focused on the growing linkages between technology, particularly in the form of social media and online marketplaces, and more traditional consumer finance industries.


SDNY Decision Blocks National Bank Charters for FinTech

By William S. C. Goldstein

FintechEarlier this month, a federal district court in New York handed a win to the New York State Department of Financial Services (DFS) in its long-running, closely watched suit seeking to block the Office of the Comptroller of the Currency (OCC) from issuing national bank charters to non-bank financial technology (FinTech) companies that don’t receive deposits.  Judge Victor Marrero denied most of OCC’s motion to dismiss and found the agency’s interpretation of the National Bank Act, 12 U.S.C. § 21 et seq., to be unpersuasive.  Vullo v. Office of the Comptroller of the Currency, No. 18-cv-8377, 2019 WL 2057691, at *18 & n.13 (S.D.N.Y. May 2, 2019).  DFS’s suit has significant stakes for the FinTech industry: under the United States’ dual banking system, nationally chartered banks are regulated primarily by OCC and avoid the application of most state laws and regulations through federal preemption, while financial institutions without national bank charters are generally subject to state oversight—and non-bank institutions are often regulated by multiple states. Id. at *8.  Judge Marrero’s decision casts doubt on whether comprehensive, uniform regulation of FinTech companies can be achieved without congressional action.

The OCC allegedly first began considering whether to accept applications from FinTech companies for special purpose national bank (SPNB) charters in early 2016, pursuant to a 2003 regulation authorizing such charters for entities engaged in “at least one” core banking function: receiving deposits, paying checks, or lending money. Id. at *2 (quoting 12 C.F.R. § 5.20(e)(1)(i)).  DFS first sued OCC in 2017, arguing that the National Bank Act (NBA) prohibits charters from issuing to entities that don’t receive deposits and that to issue them would violate the Tenth Amendment of the Constitution.  That suit was dismissed without prejudice in December of 2017 on justiciability grounds after Judge Naomi Reice Buchwald found that DFS had not suffered an injury in fact and that its claims were not ripe. Id. at *3.  After OCC announced in July of 2018 that it would begin accepting applications from non-depository FinTech companies for SPNB charters, DFS sued again, under the Administrative Procedure Act (APA) and the Tenth Amendment, to prevent OCC from issuing any charters and to invalidate the underlying regulation.  OCC moved to dismiss this past February, arguing that DFS lacked standing, its claims weren’t ripe or timely, and that on the merits it failed to state a claim. Id. at *4.  Judge Marrero issued a decision on OCC’s motion on Thursday, May 2.

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CSBS Releases Recommendations for FinTech Regulators

By Camila A. Connolly

New-Update-IconOn February 12, the Conference of State Bank Supervisors (CSBS) released its Fintech Industry Advisory Panel Recommendations.  CSBS is a national organization of financial regulators from around the United States, Guam, Puerto Rico, American Samoa, and the US Virgin Islands.  The recommendations are designed to improve the use of regulatory technology and harmonize regulatory standards throughout the United States.  The recommendations include a plan to develop a model state law for MSBs and to standardize licensing requirements.  The panel also recommended a pilot program for building a uniform state licensing examination.  Overall, the recommendations seek to create uniformity in state FinTech licensing and regulation.  To aid in the harmonizing process, the panel recommends creating repositories of the different state laws and licensing requirements so that financial companies can access all necessary regulations at once.  CSBS includes these recommendations as part of a broader effort to streamline state FinTech regulation called Vision 2020.  Read the full list of recommendations here.


Crypto Winter Continues With Ongoing Enforcement

   

By Michael W. Ross, Andrew J. Lichtman and Emily A. Bruemmer

Crypto-winterSeveral recent “first of kind” enforcement proceedings continue the flurry of enforcement activity by regulators.  In two settled proceedings, the Securities and Exchange Commission (SEC) brought two cases for failure to register digital tokens as securities in connection with initial coin offerings (ICOs), without allegations of fraud.  With such enforcement actions now commonplace, a “crypto winter” has clearly set in.  In another development, a federal court recently issued the first opinion concluding that the SEC had failed to establish that a digital asset issued in connection with an ICO was a “security” under the federal securities laws, underscoring that digital assets will not be subject to a one-size-fits-all analysis.

As for the two settled charges, according to the SEC’s orders, Paragon Coin, Inc.[1] and AirFox[2] launched their ICOs in 2017.  Paragon is an online company that was established to implement blockchain technology in the cannabis industry, as well as to work towards legalization of cannabis.  Through its ICO, Paragon raised approximately $12 million in digital assets to develop and expand its business.  As for AirFox, it sells mobile technology intended to allow customers to earn free or discounted data by watching advertisements on their phones.  AirFox raised approximately $15 million in its ICO to help expand its business overseas.  Neither Paragon nor AirFox registered their ICOs.

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