OCC Victory Not a Clear Win for Fintech Charters

In Short

The Situation: The Court of Appeals for the Second Circuit reversed the judgment of the Southern District of New York ("SDNY") in Lacewell v. Office of the Comptroller of the Currency. The Second Circuit ruled in favor of the Office of the Comptroller of the Currency ("OCC"), reversing on procedural grounds the SDNY's decision enjoining the OCC from issuing special purpose national bank ("SPNB") charters to nondepository financial technology ("fintech") firms.

The Result: The Second Circuit did not rule on the merits of the challenge by the New York State Department of Financial Services ("NYDFS"), New York's banking regulator, to the OCC fintech charter. The Second Circuit chose not to take a position on whether the "business of banking" under the National Bank Act ("NBA") requires the acceptance of deposits as a condition to eligibility for an OCC charter. Instead, the Second Circuit dismissed the case without prejudice after deciding that the NYDFS lacked standing and that its claims were not constitutionally ripe.

Looking Ahead: The Second Circuit's dismissal of the case on standing and ripeness grounds all but guarantees further litigation in the event the OCC grants a SPNB charter to a fintech company. However, both the NYDFS and the OCC have publicly announced their willingness to cooperate to address consumer protection, safety and soundness, and fairness issues. In the meantime, a fintech company applying for a SPNB charter should be aware that the OCC's authority to issue such charters has not been decided by the courts, and any charter granted by the OCC will likely result in further litigation by state regulators.

On June 3, 2021, the Court of Appeals for the Second Circuit issued a decision in the OCC's appeal of the SDNY decision in Lacewell v. Office of the Comptroller of the Currency in which the NYDFS had successfully challenged the OCC's authority to grant SPNB charters to nondepository fintech companies. The Second Circuit reversed the SDNY's judgment and ordered dismissal of the NYDFS's complaint without prejudice. While this may appear to be a victory for the OCC, the reality is more complicated.

Challenges to the OCC Fintech Charter

The underlying dispute in Lacewell began in July 2018 when, in order to address business questions raised by the Second Circuit's decision in Madden v. Midland Funding LLC, the OCC announced its plan to issue fintech charters to nondepository fintech companies. The OCC's decision to issue fintech charters was in response to the fact that the Madden decision limited the ability of nonbank debt purchasers to benefit from the NBA's preemption of state usury law, which is key to the business models adopted by many fintech companies that are not themselves nationally chartered banks and which oftentimes partner with banks to originate loans, which are immediately sold to the fintech company. For an in-depth look at the background and significance of the complaint filed by the NYDFS in the SDNY, as well as the significance of the SDNY's judgment in favor of the NYDFS, see Jones Day's January 2020 Commentary OCC Fintech Charter Headed to the Second Circuit.

The OCC's fintech charter rules were almost immediately challenged by state government regulators in both New York, in Lacewell, and in Washington, D.C., in Conference of State Bank Supervisors v. Office of the Comptroller of the Currency. While the Washington, D.C., case was dismissed twice for lack of standing and ripeness, the NYDFS prevailed in the SDNY in Lacewell. In Lacewell, the SDNY held that the NYDFS's allegations that fintech charters would "lead to the preemption of state law and thereby reduce [the NYDFS's] regulatory power, to the detriment of New York consumers" and that the NYDFS "faces the prospect of losing revenue from assessments it currently levies against nondepository fintechs, which may opt to convert to a federal SPNB charter" were sufficient to confer Article III standing upon the NYDFS. Lacewell, Case No. 19-4271 at 8.

The SDNY further held that the NYDFS claims were ripe for review because the NYDFS "had sufficiently alleged that the OCC's execution of the fintech charter decision was imminent and that there was a substantial risk that the OCC could grant an SPNB charter to a nondepository fintech at any time, thereby injuring [the NYDFS]." Lacewell, Case No. 19-4271 at 5. Finally, the SDNY concluded that the term the "business of banking" in the NBA unambiguously requires federally chartered institutions to accept deposits. Id.

Following the SDNY judgment, the Conference of State Bank Supervisors ("CSBS") again filed a complaint against the OCC in the District Court for the District of Columbia seeking declaratory and injunctive relief, arguing that the OCC lacks the authority to issue fintech charters.

OCC Appeal to the Second Circuit

The OCC appealed the SDNY judgment, arguing, inter alia, that the SDNY erred in holding both (i) that the NYDFS had Article III standing and that the claims pursued by the NYDFS were constitutionally ripe and (ii) that the "business of banking" under the NBA unambiguously requires the receipt of deposits.

Finding in favor of the OCC, the Second Circuit held that the alleged risk of preemption of New York state law was too speculative to meet the requirements to confer Article III standing on the NYDFS because no nondepository fintech company had yet applied for a fintech charter (let alone been granted one), and therefore no state laws or regulations were preempted. The Second Circuit held the NYDFS claims were not constitutionally ripe for adjudication for similar reasons.

Further, the Second Circuit found no evidence that the OCC intended to grant any fintech charters imminently. The Second Circuit was similarly unpersuaded by the NYDFS's allegation that it faced a substantial risk of loss of revenue, holding that "until a nondepository fintech that [the NYDFS] currently regulates—or would otherwise regulate—decides to apply for an SPNB charter, this alleged assessment loss will remain purely conjectural or hypothetical, rather than imminent as the Constitution requires." Lacewell, Case No. 19-4271 at 11. Finding that the NYDFS lacked Article III standing, the Second Circuit did not address whether the "business of banking" under the NBA requires the receipt of deposits. (Nonetheless, the question of what constitutes the business of banking is increasingly being litigated in a variety of contexts. For example, on June 1, 2021, in MoneyGram Int'l, Inc. v. Commissioner of Internal Revenue, Case No. 20-60146, the United States Court of Appeals for the Fifth Circuit reiterated that for an institution to be considered a bank under the U.S. tax code, it must "be a bank under the common understanding of that term" and therefore must "recei[ve] deposits from the general public, repayable to the depositors on demand or at a fixed time.")

The Second Circuit's decision is a victory for the OCC but only with regard to the standing and ripeness questions that were decided. In practical terms, the decision can be viewed as a victory for the NYDFS, as it is hard to imagine any fintech companies seeking a fintech charter given the uncertainty because the court ruled for the OCC on procedural grounds only.

The Second Circuit's decision does not address the substantive question of the OCC's legal authority to grant a fintech charter to a company that does not take deposits. While the Second Circuit reversed the SDNY's judgment, the Lacewell decision provides insight into how the SDNY may decide future similar legal challenges if the standing and ripeness requirements are met. Likely, because of the possibility of further litigation on this substantive question, no fintech company has yet applied for a fintech charter.

Following the Second Circuit's decision in Lacewell, and likely as a direct result of that decision and the probability its complaint would again be dismissed for lack of standing, the CSBS filed an unopposed motion to stay its litigation in Washington, D.C. Conference of State Bank Supervisors v. Office of the Comptroller of the Currency, Case No. 1:20-cv-03797 [ECF 15].

The Regulatory Horizon

Although the future of the fintech charter is not yet settled in the courts, recent public announcements by the Superintendent of the NYDFS and the Acting Comptroller of the Currency suggest that the regulators may coordinate and work together to address the financial needs of consumers, recognizing the need to address consumer protection, safety and soundness, and fairness.

In a statement issued on the day of the Second Circuit's decision, the Superintendent promised that the NYDFS would continue to "guard[] against any encroachment on the state regulatory system which is traditionally more consumer protective," saying, "States are the vanguards of consumer protection which is more important now than ever given the global pandemic and resulting economic crisis which has disproportionately adversely affected communities of color and women."

The Superintendent's statement looked to the new leadership at the OCC to work together with the states to address both safety and soundness and consumer protection, stating:

With new leadership at the OCC, we urge them to reconsider this ill-advised [fintech charter] program. It is incumbent upon us to work together in our dual state-federal financial system to ensure both safety and soundness of industry and protection of the consumers who rely on financial products and services.

On his first day in office, and before the Second Circuit decision was handed down, the Acting Comptroller of the Currency announced a review of key regulatory standards and matters that are pending before the OCC. The Acting Comptroller indicated that the OCC would take into account the full range of internal and external views: "I want to make sure that we distinguish the forest from the trees, that changed circumstances due to the pandemic are considered, and that all alternatives are evaluated."

In subsequent testimony before the U.S. House Financial Service Committee on May 19, 2021, the Acting Comptroller shared his perspective on licensing and charters, addressing fintech charters specifically, and indicating that the OCC must coordinate with the states and other federal financial regulators to find a way to consider how fintech charters fit into the banking system:

… Denying a [fintech] charter will not make the problem go away, just as granting a [fintech] charter will not automatically make a fintech safe, sound, and fair. I will expect any fintechs that the OCC charters to address the financial needs of consumers and businesses in a fair and equitable manner and support the important goal of promoting the availability of credit. Recognizing the OCC's unique authority to grant charters, we must find a way to consider how fintechs and payments platforms fit into the banking system, and we must do it in coordination with the FDIC, Federal Reserve, and the states.

For its part, the CSBS Executive Vice President has made clear that the CSBS is "confident that the courts will ultimately determine that Congress has not given the OCC [the] authority" to grant fintech charters and "encourage[d] the OCC to abandon its pursuit of the chartering of uninsured national banks."

Three Key Takeaways

  1. Any nondepository company that is granted a fintech charter by the OCC is very likely to face renewed litigation challenges brought by state regulatory agencies against the company and/or the OCC that will take time to resolve.
  2. Because the Second Circuit did not address the underlying legal question as to whether the OCC has the authority to grant fintech charters to companies that do not take deposits, a fintech company cannot rely on obtaining a fintech charter to avoid the interest rate preemption effects of the Second Circuit's 2015 decision in Madden v. Midland Funding LLC.
  3. Based upon recent public announcements, the future regulatory horizon for Fintech companies appears to be poised for greater focus on coordination and cooperation among the OCC, other federal financial regulators, and the states to address the financial needs of consumers, recognizing the goals to address consumer protection, safety and soundness, and fairness. But it remains to be seen whether the regulators can find a way, outside the courts, to consider how fintech charters fit into the banking system.

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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