State Regulators Busy With Fintech Sandbox, Investigation and Settlement

by Manatt, Phelps & Phillips, LLP
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In state-specific news, Arizona opened its sandbox for fintech play, Lending Club revealed that Massachusetts is following in the footsteps of the Federal Trade Commission (FTC) and the Georgia attorney general reached a $75,000 settlement with a financial institution over unauthorized fees.

What happened

Earlier this year, Arizona announced the creation of a “regulatory sandbox program” that allows participants to obtain access to the state’s market to test innovative financial products or services without first obtaining full state licensure.

On Aug. 3, the Arizona Office of the Attorney General announced it will begin accepting applications for participation. Interested companies need to submit an application form and a $500 application fee. Applicants must meet the definition of an “innovative financial product or service” found in the governing law.

House Bill 2434, which created the program, defined an “innovative financial product or service” as “a financial product or service that includes an innovation,” with “financial product or service” defined to mean a “product or service that requires licensure under [Arizona law] or a product or service that includes a business model, delivery mechanism or element that may otherwise require a license or other authorization to act as a financial institution or enterprise or other entity that is regulated by [Arizona law].”

Applicants need to provide specific information about their proposal, including the plan to monitor and test the product and an explanation of the benefits and risks to consumers, indicating the targeted consumers as well as how the applicant plans to market to them and disclose participation in the sandbox.

In addition, applicants must provide a wind-down strategy and exit plan for the sandbox, which is open to participants for two years. At the end of this period, companies may seek an extension of up to one year in order to obtain proper licensing and authorization to launch the product or service more widely.

The AG’s office will review applications on a rolling, as-received basis and will notify applicants of a decision about entry within 90 days (which may be extended upon mutual agreement). The AG’s office—which plans to evaluate applications “holistically” to determine the applicant’s ability to conduct a test that does not subject consumers to undue risk—will consider factors such as capitalization, insurance or bonds and their terms, compliance or legal support, cash on hand, and the number and expertise of active advisors and key personnel.

Meanwhile, in Massachusetts, Attorney General Maura Healy is investigating Lending Club’s advertising and disclosure practices, the company revealed in its quarterly 10-Q filing with the Securities and Exchange Commission.

“In June 2018, the Company received a civil investigative demand from the office of the Attorney General of the State of Massachusetts relating to the Company’s advertising and disclosure practices with respect to Massachusetts’ consumers,” according to the regulatory filing. “The Company is cooperating with the investigation. This matter is in its early stages and the Company is not able to predict with certainty the timing, outcome, or consequence of the investigation.”

The investigation follows an FTC lawsuit in April, accusing Lending Club of making false promises to consumers that its loans contained “no hidden fees” and then charging hundreds or even thousands of dollars in fees consumers were not expecting.

According to the FTC, the California-based company violated Section 5 of the FTC Act as well as the Privacy of Consumer Financial Information Rule, issued pursuant to the Gramm-Leach-Bliley Act.

The 10-Q filing noted that Lending Club has filed a motion to dismiss the FTC suit (with a hearing on the issue set for September) and also faces a shareholder derivative suit as well as class actions following the announcement of the FTC litigation.

Finally, the Georgia AG announced a settlement with PHH Mortgage Corporation, a national mortgage company that has figured prominently in CFPB-related litigation, after asserting it charged consumers whose mortgages it serviced for third-party products and services without their knowledge or consent.

PHH marketed various third-party products and services such as insurance products and home warranty programs to its customers. But the company ran afoul of the Georgia Fair Business Practices Act when it included charges for the products and services on consumers’ mortgage bills, the AG alleged, often without customers’ knowledge or consent.

To resolve the allegations, the company agreed to comply with the state law going forward, refrain from soliciting Georgia customers’ purchase of and/or enrollment in third-party products and services, and cease all billing for such products and services. Each consumer currently being billed will also receive notice about the change and be informed that he or she may cancel the remainder of the contract without penalty.

The company will pay $25,000 in restitution to consumers who were charged for the products and services as well as $50,000 to the AG’s office in fees, penalties, investigation and litigation costs, and future consumer protection and consumer education costs.

“Our office will hold accountable those that use deceptive means to profit from consumers,” Georgia Attorney General Chris Carr said in a statement.

To submit an application for the Arizona sandbox, click here.

To read Lending Club’s 10-Q filing, click here.

To read the Georgia AG’s announcement about the PHH settlement, click here.

Why it matters

With the CFPB generally retreating from the consumer financial scene, it is important to keep in mind that some state regulators are active. Arizona’s new sandbox should be viewed as a positive development, creating the opportunity for fintech and other companies to test new concepts without first having to touch every regulatory base. But the Massachusetts investigation into Lending Club and the Georgia AG’s recent enforcement action show that states will fill the enforcement void created by the CFPB pullback.

 

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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