Regulatory Developments Affecting Non-Banks Obrea Poindexter Sean Ruff

November 6, 2015

Marketplace Lending

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• Marketplace lending covers a wide range of Internet-based lending arrangements

– The borrowers may be individuals, small businesses or institutions – The lenders/investors may be individuals, banks, institutions,

securitization vehicles, etc.

• Marketplace lending includes peer-to-peer (“P2P”) lending

• Marketplace lending is also viewed as “debt crowdfunding”—that is, funding through debt rather than equity investments

What Is Marketplace Lending?

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• Federal and state banking laws and regulations • Federal and state securities laws and regulations • Consumer protection laws and regulations • Privacy laws

What Laws and Regulations Apply?

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• Marketplace lending activities may be regulated under state lender licensing laws

– Non-bank consumer lenders may be subject to licensing obligations in a majority of states

– Non-bank commercial lenders may be subject to licensing obligations in a minority of states

• State licensing regimes for non-bank lenders require extensive disclosures in the licensing application

– Such disclosures may include financial statements, management/ organizational information and background checks (and fingerprinting) for control persons

• Licensees will be subject to minimum net worth and surety bond requirements, and to examination by state licensing authorities and restrictions on owners/control persons

• Non-bank lenders are generally subject to state rate restrictions (i.e., usury laws)

Overview of Lending Laws & Regulations

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• Bank partnerships may avoid state licensing obligations and rate restrictions

– Federal law authorizes federally insured banks to charge interest authorized by the state in which they are located without regard to usury laws of other states (i.e., to “export” rate rules from their home state) The ability of non-banks to rely on a partner bank’s rate exportation has been

called into question in Madden and CashCall – Bank partners that originate consumer loans will have compliance

obligations under consumer protection laws, discussed below

• Platform operators, independently or through their bank partnership, may have Bank Secrecy Act (“BSA”)/anti-money laundering (“AML”) obligations

– Such obligations may include customer identification, screening, reporting and/or recordkeeping

Overview of Lending Laws & Regulations

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• Madden v. Midland Funding, LLC, No. 14-2131-cv (2d Cir. 2015) • Facts:

– Plaintiff, a New York resident, opened a credit card account with Bank of America, N.A. (“BOA”) in 2005, which later transferred the account to FIA Card Services, N.A. (“FIA”)

– Around the time of transfer, the terms of Plaintiff’s account were amended by Plaintiff’s receipt of a Delaware law-governed “Change in Terms” document

– In 2008, FIA determined Plaintiff’s debt was uncollectable, and sold the debt to Defendants

– In November 2010, Defendants sent Plaintiff a letter seeking to collect payment on her debt, stating that an annual interest rate of 27% applied

Overview of Lending Laws & Regulations

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• Madden v. Midland Funding, LLC, No. 14-2131-cv. (2d Cir. 2015) • Procedure:

– Plaintiff filed suit in 2011, alleging that Defendants: Engaged in abusive and unfair debt collection practices in violation of the

Fair Debt Collection Practices Act (“FDCPA”) Charged a usurious rate of interest in violation of New York law, which caps

interest at 25% per year – Defendants argue that Plaintiff’s claims fail because:

The FDCPA and usury claims are based on state-law violations against a national bank’s assignees, and are therefore preempted by the National Bank Act (“NBA”)

The Change in Terms specifies Delaware law, under which the interest rate charged is allowed

– The District Court found in favor of the Defendants and the Plaintiff appealed

Overview of Lending Laws & Regulations

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• Madden v. Midland Funding, LLC, No. 14-2131-cv. (2d Cir. 2015) • Holding:

– The Second Circuit reversed the District Court’s holding regarding the NBA preemption, vacated the District Court’s judgment and denial of class certification, and remanded the issue as to whether Delaware law applies because it was not addressed by the District Court

• Rationale: – Though the NBA may preempt state usury law with respect to national banks,

thereby allowing FIA, located in Delaware, to charge interest rates that would be usurious under New York law, the NBA preemption does not extend to Defendants as FIA’s assignees

– The U.S. Supreme Court has suggested that the NBA preemption may extend to “non-national banks acting as the ‘equivalent to national banks with respect to powers exercised under federal law,’” e.g., subsidiaries or agents of national banks

– Unlike subsidiaries or agents, the Defendants were not acting on behalf of a national bank but were only acting on behalf of themselves as owners of the debt

– In addition, the Second Circuit asserted that application of state laws would not “significantly” interfere with either national bank’s ability to exercise its powers under the NBA

Overview of Lending Laws & Regulations

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• Consumer lending activities are subject to a range of consumer protection laws, including laws enforced by the Consumer Financial Protection Bureau (“CFPB”)

– The CFPB has aggressively enforced consumer protection laws against banks and non-banks, with potential for significant civil money penalties

• Consumer protection laws include – The federal Truth in Lending Act, which imposes disclosure

requirements on lenders and creates substantive rights for borrowers – Federal fair lending laws, including the Equal Credit Opportunity Act,

which prohibit discrimination in credit transactions (consumer or business credit) Also, the U.S. Supreme Court’s recent holding in Inclusive Communities

regarding disparate treatment – Federal and state debt collection practices laws, which regulate the

conduct of debt collectors – Federal and state privacy laws, which may regulate use and disclosure of

consumer data – The UDAAP/UDAP authority of the CFPB, Federal Trade Commission

(“FTC”) and/or state attorneys general

Overview of Lending Laws & Regulations

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• There have been a number of recent regulatory and self-regulatory initiatives that touch marketplace lending

– In August 2015, the Responsible Business Lending Coalition published a Small Businesses Borrowers’ Bill of Rights, which identifies certain rights for small business borrowers (e.g., the right to transparent pricing and terms and the right to non-abusive products)

– In July 2015, the U.S. Treasury issued an RFI on online marketplace lending The RFI sought to obtain information on the various marketplace lending

models and the potential for marketplace lending to expand access to credit The U.S. Treasury is also hosting roundtables to supplement information

obtained through the RFI – In March 2015, the CFPB announced that it is considering proposing

rules to regulate certain online lending activities (e.g., “payday” loans and other short-term loans)

Recent Regulatory Initiatives

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• The CFPB has said that it plans to issue a proposed rule on payday, auto title, and certain other longer-term loans in late 2015

– The comment period is likely to be 60 days or 90 days

• Issuance of a final rule is anticipated to be in the Summer to Fall 2016 timeframe

– With a 6- to 12-month compliance period

• Covered short-term loans would have a duration of 45 days or fewer

• Covered longer-term loans would have a duration of longer than 45 days and a total APR of more than 36 percent, where the lender has access to the consumer’s deposit account or paycheck, or holds a security interest in the consumer’s vehicle

CFPB Proposal on Short-Term and Other High-Interest Loans

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• Covered Short-Term Loans – Option One

• Determine ability to repay • 60-day cooling off period between loans unless improved circumstances

– Option Two • Less than $500

–No more than one finance charge –No vehicle as collateral

• Extended repayment plan • Limitations on re-borrowing

CFPB Proposal: Covered Short-Term Loan Options

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• Covered Longer-Term Loans – Option One: Ability to Repay

• Determine ability to repay • Special rules for balloon payments

– Option Two: NCUA PAL Terms • 28% rate cap • Application fee capped at $20 • Loan between $200 and $1,000

– Option Three: 5% PTI Terms • Monthly payments no more than 5% GMI • No prepayment fee • No more than two such loans within 12-month period

CFPB Proposal: Covered Longer-Term Loan Options

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• The lender must make a reasonable determination whether the consumer “will have enough remaining income” to

– Repay the loan – Fulfill “major financial obligations” and – Meet living expenses – Without re-borrowing during the “underwriting period” (loan term + 60 days for

short-term or longer-term with a balloon payment)

• The lender must consider and verify – Amount and timing of income – Major financial obligations – Consumer’s borrowing history

• Use of at least one credit bureau, and furnishing to credit bureaus would be required

• According to the CFPB, a lender’s “ability to repay” determination may not be reasonable if borrowers consistently re-borrow or default

CFPB Proposal: Ability to Repay (Longer-Term Loans)

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• Verify borrowing history, as well as amount and timing of income

• Report loan to all CFPB-approved credit bureaus

• Maintain records documenting actions until 36 months after last entry

– Ability-to-repay determination, verification of borrowing history, history of payment presentments etc.

• Payment reminder three business days before attempt to collect

• Obtain new authorization if two consecutive attempts to collect from consumers’ accounts are unsuccessful

• Establish and maintain written policies and procedures that meet the rule’s requirements (e.g., for determining ability to repay)

CFPB Proposal: Requirements Applicable to All Covered Loans

Money Transmission

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• A comprehensive set of state and federal laws and regulations – 47 states and the District of Columbia require a license to transmit

money (in some form) – Federal oversight of money transmitters may include

Financial Crimes Enforcement Network (“FinCEN”) CFPB Office of Foreign Assets Control (“OFAC”) FTC Internal Revenue Service (“IRS”)

• State licensing is generally from the perspective of safety and soundness

– Regulators focus on licensing and daily oversight • Federal regulators and programs (FinCEN, IRS, OFAC) primarily

focus on AML and anti-terrorism financing – Plus a new focus on consumer protection and compliance at the federal

level from the CFPB

Regulatory Landscape for Money Transmission

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• Federal laws and regulations are primarily concerned with: – AML/anti-terrorism financing compliance

BSA OFAC sanctions

– Consumer protection Regulation E (electronic funds transfer) Remittance Transfer Rule Unfair or deceptive acts or practices

Federal Regulation

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• The BSA was enacted in 1970 in response to concerns about the proceeds of illegal activities being laundered through bank accounts

– The USA PATRIOT Act, passed in 2001, significantly amended the BSA – The BSA is implemented by FinCEN – FinCEN regulations require non-bank MSBs to:

Register with FinCEN Maintain an AML program File currency reports (if applicable) and reports of suspicious transactions Identify persons conducting transactions Maintain records of financial transactions

Federal–Bank Secrecy Act

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• FinCEN identifies seven types of MSBs, including providers and sellers of prepaid access and money transmitters

• Exemptions and limitations – Activity-level thresholds relating to prepaid – Exemptions for certain types of “payment processing”

• Whether an entity is an MSB is a “question of facts and circumstances”

– A number of FinCEN rulings and interpretations of whether specific scenarios are “money transmission”

• But after all that, still may be considered a “money transmitter” under state licensing laws

– And if you are an MSB under state law, you need to register with FinCEN and have an AML program

Federal–Bank Secrecy Act

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• OFAC administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals

• Under OFAC guidelines, although a sanctions compliance program is not required, the existence of a risk-based OFAC compliance program is used by that agency in determining whether to seek civil penalties and/or criminal penalties for even inadvertent violations

– The statutes administered by OFAC generally impose strict liability; that is, even without specific intent to violate the law

• U.S. companies (both banks and non-banks) typically screen customers against the OFAC Specially Designated Nationals list to comply with OFAC regulations

Federal–Office of Foreign Assets Control

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• Consumer protection is the core concern of state money transmission regulation

– Safety and soundness – Fraud prevention and protection

• State statutes generally define “money transmission” broadly to include the receipt of funds and transmission of the same

– The statutes also identify specific types of funds transfer related activities, including issuing money orders, stored value and traveler’s checks

• Entities that conduct activity that comes within the definition of “money transmission” must be licensed in (almost) all states in which they have customers, unless the activity is otherwise exempt

State Money Transmission Regulation

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• Some states, by statute, regulation or guidance, have explicit exemptions for situations in which an entity receives funds on behalf of the merchant (or payee), as opposed to receiving funds for transmission from the consumer

• In some states, the statute simply exempts an “agent” of the payee/biller

• In other states, the exemption is more detailed – Both California and Virginia exempt payee agents subject to specific

conditions being met – Illinois has determined that “payment processing” is not money

transmission

• All of these exemptions acknowledge that when a consumer gives his money to a (common law) agent, it is as if the funds have been received by the principal, and the consumer faces no risk of harm

– From the consumer’s point of view, the transaction is complete

State Regulation–Exemptions

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• In light of the broad definitions of money transmission, and the payee agent/payment processing exemptions, what makes an entity a money transmitter?

– Receiving and sending funds on behalf of a sender of funds? – Receiving funds on behalf of a business (like bill payment)? – What if there is a contractual relationship? – Processing payments at the point of sale? – Providing clearing or other back-end reconciliation services to

merchants? – Virtual currency and virtual currency exchanges?

Am I a Money Transmitter?

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• What is “payment processing?” – Credit card data processing – Merchant payment acceptance – Back-end clearing services – Biller agency relationships?

• What makes a service payment processing and not money transmission?

– Service provided on behalf of the merchant, not the customer – Contractual agency agreement – Proximity between “processor” and merchant

Money Transmission and “Payment Processing”

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• Must obtain licenses in each state where you will do business (i.e., have customers) with a few exceptions

• Getting licensed – Process varies by state, but generally involves

Completing applications (most states have their own application, but the National Mortgage Licensing System [“NMLS”] allows for a single, simultaneous electronic filing of applications in a number of states)

Bonding (minimum aggregate amount is now around $7-8 million for all states that license money transmitters)

Application fees (closing in on $90,000 in aggregate) – Applications generally require

Background information about the entity Business plan AML program Biographical and financial information about the executive officers and

directors

• Money transmitters must register with FinCEN and have an AML program (same program for state and federal compliance)

If You Are a Money Transmitter…

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• Maintaining licenses – Renewal requirements – Maintaining an AML program – Examinations of compliance with state and federal law

Federal examiners include FinCEN, IRS and CFPB

• Recordkeeping, reporting and disclosure obligations – Receipt disclosures – Maintenance of permissible investments – Recordkeeping requirements

Records of payments and outstandings, a general ledger Additional records relating to money laundering compliance, such as

suspicious activity reports and reports relating to large transactions – Reporting requirements

Ordinary (annual financial audits, changes to the business) Not so ordinary (significant events such as filing for bankruptcy or

reorganization)

Life as a Licensee

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• Non-compliance with federal obligations – Chief Compliance Officer may be subject to personal fine

“Top compliance staffers at global companies have rarely faced such penalties, and the penalty is a sign that FinCEN is following through on its promises to increasingly hold individuals responsible for lapses in corporate controls. Other regulators are vowing to take the same approach.”

Wall Street Journal, Dec. 18, 2014 – PayPal paid $7.7 million fine over U.S. sanctions

“The company’s processing of about 500 payments from 2009 to 2013 included ones tied to weapons of mass destruction, as well as related to Iran, Sudan and Cuba.”

CNET, Mar. 26, 2015

• Non-compliance with state licensing laws – If regulators think you are conducting money transmission without a

license, they will typically invite you to apply for a license as part of a resolution Often fines based on unlicensed transaction volume and intent, settlement

agreements, consent orders, etc.

Enforcement Actions

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• Why be a money transmitter? – Provide services that are clearly money transmission (P2P payments) – Expand or add new services without needing further regulatory approval – Certainty in an uncertain regulatory landscape

• Why avoid becoming a licensed money transmitter? – Business model limitation – Compliance infrastructure – Increased regulatory scrutiny

Operating as a Money Transmitter– Pros and Cons

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