Noteworthy developments in payments and fintech - March 2021

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Industrial bank charters continue to gain momentum with approval of Square’s charter; payments and tech companies have become interested in industrial banks lately since the FDIC started approving them after a moratorium from 2006.

Last month, Square began operation of its Utah industrial bank following its successful completion of the approval process with the Utah Department of Financial Institutions and the FDIC. Square Financial Services, Inc. will be Utah’s sixteenth industrial bank. Square first submitted its charter application in September 2017 and gained conditional approval of its industrial bank in March 2020. It was approved to open for business as of March 1, 2021. According to Square, Square Financial Services will offer deposit products and small business loans for Square Capital’s commercial lending business. It will likely focus on merchants that use Square for merchant payment processing services.

A major advantage of the state industrial bank charter over other charter types is that a non-financial parent company can own an industrial bank without becoming a bank holding company subject to the Bank Holding Company Act of 1956 (BHCA) and related supervision by the Federal Reserve. The BHCA limits permissible activities for bank holding companies and requires them to comply with arduous reporting and capital requirements. The unique opportunity to own a full-service bank and yet avoid BHCA requirements makes the industrial bank charter both attractive and controversial.

Although industrial banks are state-chartered, they take retail deposits and so are FDIC insured. The FDIC had imposed a moratorium on approving new industrial banks in 2006 following controversial charter bids by Walmart and Home Depot. The industrial bank moratorium, which had been extended by the Dodd-Frank Act, expired in 2013. However, the FDIC did not receive any formal industrial bank charter applications until Square and Nelnet Bank filed in March of last year. Since then, interest in the charter has steadily increased as financial services and fintech companies that want to offer money transfer, payment, loan and other financial services seek out alternatives to state-by-state money transmitter licensing requirements and other state level regulations and restrictions, such as interest rate caps. The FDIC also lit the path for would-be charter applicants by issuing a final rule in December 2020 establishing clear requirements for parent companies of industrial banks. Nelnet started operating as a Utah-chartered industrial bank in September 2020. Other companies with industrial bank charters in process include GM Financial, Edward Jones, and Rakuten.

Second Circuit oral arguments raise questions about future of OCC fintech charter program and ripeness of New York’s challenge

The Officer of the Comptroller of the Currency has also tried to offer an alternative to state-by-state money transmission licensing for fintech companies with its special-purpose national bank charter for non-depository fintech firms, often referred to as the fintech charter. The OCC fintech charter has been plagued by a thus-far successful legal challenge from the New York Department of Financial Services. The OCC appealed a district court’s ruling in favor of the NY DFS to the Second Circuit, and the court heard oral arguments on the case on March 9, 2021. While we can’t predict how the Second Circuit will rule, the Second Circuit panel of judges seemed particularly interested in the question of whether the NY DFS had standing to challenge the OCC fintech charter at this time given that there are no pending applications for the charter. See our prior legal alert for more information on this development.

Congressional Democrats introduced a joint resolution to scrap the OCC’s True Lender rule using the Congressional Review Act, which would avoid a Senate filibuster. If passed by a simple majority in both houses, the resolution will void the True Lender rule and prevent the OCC from issuing a “substantially similar” rule in the future.

On March 25, Democratic Senators Chris Van Hollen and Sherrod Brown introduced a joint resolution under the Congressional Review Act (CRA) that would invalidate the OCC’s so-called “True Lender” rule. The rule, issued in October 2020, is meant to clarify that a bank operating a loan program in partnership with a non-bank (such as a fintech lending platform) is the lender for compliance purposes as long as it either funds the loan or is named as the lender in the loan agreement, even if the loan is subsequently sold to the non-bank partner or other third party. This is important because, with a national bank as the lender, program loans are exempt from state licensure requirements and interest-rate caps.

Consumer advocacy groups and state regulatory agencies have been vocal opponents of the true lender rule, which they view as allowing ficntechs and other non-bank lenders to make an end-run around state consumer protections. In January, seven states filed suit against the OCC in an attempt to block the rule.

A resolution of disapproval under the CRA requires only a simple majority to pass both houses and is subject to a special “fast track” procedure for consideration in the Senate that avoids filibuster. However, these special procedures are only available for a limited time after the rulemaking. Depending on how often Congress meets in the coming weeks, the “fast track” period for the CRA resolution introduced last month will expire sometime in May. After that, the resolution would have to be considered using normal Senate procedures.

Given the Democrats’ slim majority in the Senate, it is not clear that the current joint resolution will succeed. Success may also have a downside for Democrats and other opponents of the true lender rule. Once Congress has invalidated a rule under the CRA, the issuing agency cannot promulgate a “substantially similar” rule without new authorizing legislation. The meaning of the term “substantially similar” is ambiguous, meaning that invalidation under the CRA creates uncertainty regarding the OCC’s ability to pursue a new rule addressing the true lender issue.

The CFPB signals a tougher stance by rescinding several Trump-era policy statements and indicates that it will use its abusiveness authority under UDAAP to its full extent

Last month, the CFPB signaled its return to the pro-consumer stance of its first five years by rescinding several pro-industry policy statements issued during the Trump Administration. On March 31, the CFPB rescinded seven statements that provided financial services companies with additional flexibility with respect to certain compliance requirements for mortgages, credit reporting, and credit and prepaid cards in response to the Covid-19 pandemic. Additionally, the CFPB reversed Bulletin 2018-01, which had provided for examiners’ use of Supervisory Recommendations (SRs) to “recommend actions for management to consider taking” to address identified weaknesses in the company’s compliance management system. Going forward, CFPB examiners will rely on Matters Requiring Attention (MRAs) to convey supervisory expectations. Neither SRs nor MRAs are legally enforceable, and both can be issued independently of any violation of law. However, unlike SRs, MRAs provide timeframes for corrections and periodic reporting.

Finally, the CFPB announced its rescission of a Trump-era policy statement that limited the circumstances under which the agency would bring claims for alleged abusive practices by financial services providers under UDAAP. The CFPB stated that it will instead “exercise its supervisory and enforcement authority consistent with the Dodd-Frank Act and with the full authority afforded by Congress.”

The Bureau’s use of its abusiveness authority had been a particular focus of its critics because, unlike the standards for unfair and deceptive practices, it does not benefit from decades of interpretation by the FTC. Rather, the abusiveness standard was created by the Dodd-Frank Act in 2011 and entrusted to the newly-formed CFPB to interpret. In its first five years, the CFPB frequently appended abusiveness claims to claims of unfairness or deceptiveness based on the same conduct. This made it difficult to determine what criteria the Bureau was using to identify abusive conduct. The result, according to industry critics, was excessive vagueness and stifling of innovation.

In response to these concerns, in 2019, the Bureau held a symposium on the Dodd-Frank Act’s abusiveness standard and issued a policy statement intended to address industry feedback on the lack of clear criteria for identifying abusive practices. In that statement, the CFPB stated that it would make three changes to its use of its abusiveness authority under UDAAP:

  • it would subject any potential abusiveness claim to a cost-benefit analysis and bring a claim only if the consumer harm associated with the practice outweighed the benefits;
  • it would avoid pursuing a claim of abusiveness in tandem with a claim of unfairness or deceptiveness that was based on the same conduct; and
  • it would seek civil money penalties or disgorgement for an abusive practice only where the covered entity had acted in bad faith. 

The CFPB also signaled in the same 2019 policy statement that it was considering using its rulemaking authority to provide “clear rules of the road” regarding the abusiveness standard. The Bureau did not, however, begin a formal abusiveness rulemaking prior to President Biden’s inauguration.

The CFPB noted in its March 2021 policy statement that it did not find the rescinded 2019 policy statement helpful and considered the statutory standard for abusiveness to be sufficiently clear without additional interpretation by the agency. With that, any effort to further develop the abusiveness standard through rulemaking or formal guidance seems to be off the table.

This lack of prospective guidance means the abusiveness standard will likely continue to develop piecemeal through enforcement actions. Whether meaningful clarification around what constitutes “abusive” acts or practices under UDAAP occurs at all will depend on the extent to which the CFPB’s abusiveness claims are articulated separately from claims of unfairness or deceptiveness. At least initially, industry participants will find themselves in a familiar position – scrutinizing each new enforcement action for indications of how the Bureau is interpreting the standard.

The CFPB’s large-scale rescission of prior guidance is not surprising. A decisive pivot away from the Bureau’s previous pro-industry and low enforcement attitude was expected given the change in administration and the agency’s new leadership. Less obvious is whether the CFPB will return to its early, and often-criticized, practice of setting compliance standards by enforcement rather than rulemaking. The answer is likely to be revealed gradually as the urgency of pandemic-related issues recedes and the Bureau has more capacity to consider new and existing rules. However, the Bureau’s recent statement regarding its planned use of UDAAP authority may be an early indicator of things to come.

Visa and Mastercard announce delay of planned interchange hikes until April 2022 in response to pressure from retailers and Senator Dick Durbin and citing ongoing recovery from the Covid-19 pandemic

Visa and Mastercard announced last month that they will delay planned increases in interchange rates for another year as a result of the Covid-19 pandemic. The decision was made in the wake of requests from retailers and pressure from Senator Dick Durbin, D-Ill, who penned a letter to the networks urging them to call off the planned interchange increases. Visa noted that it previously made an interchange reduction for grocery stores and deferred interchange increases for consumer card present transactions due to the pandemic, and this latest announcement by Visa extends the moratorium on interchange hikes to ecommerce transactions. Visa has said it will delay the interchange increases until April 2022. Mastercard similarly announced that it is putting off planned interchange increases until April 2022.

Trend of retailers looking to financial services to deepen customer interaction continues with Walgreens’s announcement that it will offer bank accounts to customers

Last month Walgreens announced that it will start offering its customers bank accounts in partnership with Incomm and Metabank. The bank accounts will be issued by Metabank, and Walgreens plans to market them both online and through its retail storefronts. This follows a trend of retailers looking to broaden their interactions with customers and make those customer relationships stickier. Walgreens’ announcement comes in the wake of Walmart’s announcement earlier this year that it has formed a fintech venture with Ribbit Capital.

Kansas District Court strikes down Kansas’s statute prohibiting credit and debit card surcharging by merchants on First Amendment Grounds. The ruling is consistent with similar cases in California, New York, Texas, and Florida.

The US District Court for the District of Kansas has recently ruled that Kansas’s statute1 prohibiting merchants from imposing a surcharge on customers who elect to use a credit or debit card in place of payment by cash, check, or other similar means violates the First Amendment. The case is CardX, LLC v Schmidt, 2021 WL 736322 (D. Kan. 2021)

The Kansas statute, like several other state credit card surcharge bans, prohibits imposing a surcharge on credit card or debit card transactions but allows the merchant to offer a discount for payments made in cash. While the net economic effect of a surcharge and a discount is the same (i.e., the customer pays a higher price for using a credit card and a lower price for using cash or check), the statute limits how the merchant can communicate the price differential to the customer. The merchant can present the differential price only as a discount for using cash rather than as an additional charge for using a credit card. The Kansas court’s ruling follows several other courts that have invalidated other states’ no-surcharge laws on First Amendment grounds, including California, New York, Texas, and Florida. In Oklahoma the State Attorney General issued an opinion that the state’s no-surcharge law was unconstitutional and would not be enforced.

The analytical framework the Kansas court applied was drawn from the Supreme Court decision in Expressions Hair Design v. Schneiderman, 137 S. Ct. 1144 (2017), which addressed a constitutional challenge to the New York no-surcharge law. The Schneiderman Court held that no-surcharge laws such as New York’s did in fact regulate commercial speech because they regulated the way prices are communicated to the customer rather than regulating the prices themselves. In order to regulate commercial speech that is not misleading or related to an unlawful activity, the state must show a substantial interest to be achieved by the restriction on commercial speech, the regulatory technique must be in proportion to that interest, the limitation is carefully designed to achieve the state’s goal, and the governmental interest could not be served as well by a more limited restriction. See Central Hudson Gas & Elec. Corp. v. Public Service Commission of New York, 447 U.S. 557, 564 (1980).

The court in CardX, LLC v Schmidt found that the Kansas no-surcharge law does not advance substantial state interests in a direct and material way and in proportion to those interests and so does not survive First Amendment scrutiny. However, the Kansas court only invalidated enforcement of the Kansas law as applied to the plaintiff, CardX, LLC, i.e., prohibiting it from selling and using software that employs a single sticker price display, including display of the price and incremental surcharge amount for credit card transactions. Based on the court’s rationale in its ruling, however, we would expect similar challenges to the Kansas law by merchants to have similar results. 

Other states with no-surcharge laws still on the books that have not yet been invalidated include Colorado, Connecticut, Maine, and Massachusetts.

CFPB issues an advisory opinion that Earned Wage Access products meeting specific criteria are not subject to TILA; California uses MOUs to impose best practices and periodic reporting on several Earned Wage Access providers; South Carolina, Utah, and Georgia consider EWA legislation

Earned wage access (EWA) products allow employees to receive a portion of their accrued wages in advance of their regular payday. In the typical arrangement, a third party provider partnered with the employer processes employees’ requests for EWA advances, disburses funds in advance of the employee’s pay day, and recoups the funds through payroll deductions or debits to the employee’s bank account. Compensation structures vary, with some providers offering users the option of “tipping”, others charging mandatory per-transaction or subscription fees for all or some of their EWA products, and still others offering services at no cost to employees.

The promise of EWA products is that they offer employees a way to bridge the gap between wage accrual and payment without resorting to payday loans, pawn transactions, credit card cash advances, or other short term, high interest loan products. However, EWA products can raise some of the same consumer protection questions as these other short-term cash options, depending on the EWA provider’s fee structure, access to employees’ bank accounts, and recourse rights in the event the advance is not repaid.

Whether EWA transactions fall within the legal definition of “consumer credit” is an existential issue for EWA providers. If a court or regulator characterized an EWA transaction as a consumer loan, the provider could be subject to (and potentially in violation of) state licensure requirements and interest-rate caps that apply to consumer lenders as well as a variety of federal consumer financial protection laws, such as the Truth in Lending Act (TILA). The definition of credit, for purposes of the TILA and most other consumer financial protection statutes, is the right to defer payment of a debt or to incur debt and defer its payment.

On November 30, 2020, the CFPB attempted to resolve the classification issue with an advisory opinion concluding that EWA transactions are not extensions of credit for purposes of the Truth in Lending Act, provided that they meet the following criteria:

  • the EWA provider contracts with the employer;
  • advance amounts do not exceed accrued pay up to the time of the transaction (as determined by the employer);
  • employees do not pay a fee for the service;
  • advances are sent to an account of the employee’s choice (and, if the account is a prepaid account offered by the provider, additional fee restrictions apply);
  • the provider recoups funds solely through an employer-facilitated deduction from the employee’s next paycheck (not through a debit to the employee’s bank account);
  • if the payroll deduction fails, the provider has no recourse against the employee except refusing future EWA advances; and
  • the provider makes certain warranties to the employee, including that the transaction is non-recourse and that the provider will not engage in debt-collection activities.

A month after issuing the advisory opinion, the CFPB approved an application from EWA provider Payactiv, Inc. to offer its product pursuant to the Bureau’s Compliance Assistance Sandbox (CAS) without complying with the Truth in Lending Act. The Bureau found that Payactiv’s product did not create a debt and so was “different in kind” from consumer loans and other financial products the Bureau regulates.

Payactiv’s product aligns with the criteria set out above except that it charges employees who do not have a Payactiv-managed account a fee of $1 for an unlimited number of transactions within a one-day access window. Fees are capped at $3 or $5 per pay period, regardless of the number of days during the period that the employee requests advances. The CFPB referred to these fees as “nominal” and noted that they are comparable to expedited transfer fees for non-credit products.

The CFPB’s advisory opinion and approval of Payactiv’s CAS application are positive developments for the EWA industry. However, significant regulatory uncertainty remains. The CFPB’s advisory opinion was issued prior to President Biden’s inauguration and the ensuing change of leadership at the CFPB. The CFPB could rescind the opinion or simply decline to grant CAS approvals for new EWA applicants. Additionally, the opinion does not offer a safe harbor to EWA providers whose product deviates from the CFPB’s specific criteria (e.g., because they charge employees for the service). Finally, the Bureau’s advisory opinion is not binding on the states, which are now considering their own approaches to EWA regulation.

Legislation aimed at regulating the EWA industry has recently been introduced in a handful of states, including Georgia, South Carolina, and Utah. Although the details of the bills differ, all of them would exempt EWA providers from compliance with state consumer lending laws if they register with the state financial regulatory agency and comply with certain operational requirements.

California’s Department of Financial Protection and Innovation (DFPI), which is empowered to enforce the state’s new statutory prohibition on unfair, deceptive and abusive practices, has entered into memoranda of understanding with several EWA providers. The MOUs require the providers, whose fee structures vary significantly, to submit periodic reports on their EWA transactions and to comply with a set of best practices. 

The content of the MOUs provides some insight into the DFPI’s current thinking on EWA products. One of the DFPI’s best practices is to “comply with TILA, if applicable” and to cap the effective annual percentage rate on transactions at 36%. Additionally, the MOUs require providers to limit advance amounts to 50% of the employee’s upcoming paycheck and to report on the proportion of advances that are “rolled over” to the next pay period or deferred at the employee’s request. It appears that the DFPI has not decided whether EWA transactions are, or should be, classified as loans and is taking a hard look at consumer cost and “cycle of debt” issues typically associated with other short-term, small-dollar products.

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1Kan. Stat. Ann. § 16a-2-403

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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