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OCC Moves Forward on Fintech Bank Charters

March 16, 2017

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Amid criticism from virtually every possible constituency, on March 15, 2017, the Office of the Comptroller of the Currency (OCC) released a draft supplement  to its chartering licensing manual related to special purpose national banks leveraging financial technology, or fintech banks. As we indicated in our fintech webinar discussing the proposal last December, the OCC is proposing to apply many conventional requirements for new banks to the fintech charter. While the OCC’s approach is familiar to those of us well versed on the formation of new banks, there are a few interesting items of note to take away from the draft supplement.

  • More bank than technology firm. Potential applicants for a fintech charter should approach the project with the mindset that they are applying to become a bank using technology as a delivery channel, as opposed to becoming a technology company with banking powers. While the difference might seem like semantics, the outcome should lead potential applicants to have a risk management focus and to include directors, executives, and advisors who have experience in banking and other highly regulated industries. In order to best position a proposal for approval, both the application and the leadership team will need to speak the OCC’s language.
  • Threading the needle will not be easy. Either explicitly or implicitly in the draft supplement, the OCC requires that applicants for fintech bank charters have a satisfactory financial inclusion plan, avoid products that have “predatory, unfair, or deceptive features,” have adequate profitability, and, of course, be safe and sound. Each bank in the country strives to meet those goals, yet many of them find themselves under pressure from various constituencies to improve their performance in one or more of those areas. For potential fintech banks, can you fulfill a mission of financial inclusion while offering risk-based pricing that is consistent with safety and soundness principles without having consumer groups deem your practices as unfair? On the other hand, can you offer financial inclusion in a manner that consumer groups appreciate while achieving appropriate profitability and risk management? We think the answer to both questions can be yes, but a careful approach will be required to convince the OCC that it should be comfortable accepting the proposed bank’s approach.
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The OCC Rises, the FSOC Dies, and Other Regulatory Predictions

November 17, 2016

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Eight bold regulatory predictions on the direction of U.S. Banking and Fintech regulation in light of the election results.

1.   The era of “outside the law” Federal regulation is over. Critics of the CFPB (exclusively Republicans) have criticized and challenged the agency’s structure and tactics.  These challenges include criticism of the agency’s broad jurisdiction and rulemaking power as an unconstitutional delegation by Congress of its legislative power.  Members of Congress and private litigants have assailed the CFPB’s reliance on enforcement actions instead of true rulemaking as undercutting due process and basic fairness.  Republicans have been united in believing that the agency’s existence and actions violated the Constitution, the agency’s grant of power under Dodd-Frank and the Administrative Procedures Act.  Increasingly, the courts have dealt the agency significant setbacks.  This author believes that Director Cordray only persisted in his aggressive pursuit of policy goals because he believed that pursuit was blessed by the Obama Administration and the Democratic Party.  Whatever one thinks of President-Elect Trump and his incoming administration, we can be certain that it will not support or defend an aggressive pursuit of policy goals even when that pursuit is perceived to exceed the scope of the law.  If a CFPB official decides to pursue such an enforcement action will be doing so without political cover.  As a result, I believe the CFPB will not bring enforcement actions unless the law and the facts clearly support that decision.  This is a major change of direction for the agency.  Once the agency is limited to strictly enforcing the law and promulgating only regulations that comply with the Administrative Procedures Act, it will be able to obtain many fewer settlements (and for much lower amounts) than it was able to do before when it enforced standards that it essentially made up on the spot.

2.  Director Cordray will either resign or be fired by the President. The extent of the anger and resentment towards Director Cordray by Republicans in Congress cannot be overstated.  I suspect President Trump does not have a strong personal opinion on the matter, but his advisors are close to Congressional leaders and I think there is zero chance that Republicans will not give the Director what they see as his long-overdue comeuppance.  A recent District Court opinion supports the Constitutional authority of the President to fire the Director, but I think President Trump will not hesitate to articulate a “for cause” basis to fire the Director under Dodd-Frank if the Director were to contest the President’s power to fire him at will.

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Pointers for Bank Recipients of Demand Letters Asserting ADA Non-Compliance

October 18, 2016

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Community banks have recently been on the receiving end of demand letters from plaintiffs law firms alleging that the banks’ websites are in violation of the Americans With Disabilities Act of 1990 (the “ADA”).  Interestingly, there are currently no specific federal standards for websites under the ADA. The Department of Justice (“DOJ”) is in the process of developing regulations for website accessibility, but has announced it will not finalize these regulations until 2018 at the earliest. Even so, the DOJ has emphasized that businesses should make websites accessible to the disabled. While the regulations are being developed, many businesses have been applying the Web Content Accessibility Guidelines (WCAG) 2.0 Level AA with the understanding that the DOJ has made clear that it considers a website accessible if it complies with these guidelines.

When a bank receives a demand letter the first thing they need to do is hire counsel to advise them about their various options, including mitigating any damages by curing website defects, litigation or settlement. As a practical matter, the best defense to such claims is making sure that the bank’s website is compliant with the WCAG 2.0 Level AA Guidelines. That may involve the use of internal resources as well as external consultants.  While it is impossible to tell whether suit will be filed in any given situation, banks should take note that the firms sending demands have previously been engaged in filing over 100 of these types of suits against various non-financial defendants over the past year.

Bryan Cave has put together a resource that provides generally accepted recommendations for website accessibility and federal ADA standards for ATM accessibility to help you review how your banks stands.

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Banks and Marketplace Lenders Absorb a Blow

June 30, 2016

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In a blow to banks and the marketplace lending industry, on June 27, 2016, the U.S. Supreme Court denied the petition by Midland Funding to hear the case Midland Funding, LLC v. Madden (No. 15-610).  That case involves a debt-collection firm that bought charged-off credit card debt from a national bank.  The borrower’s legal team argued that a buyer of the debt was subject to New York interest rate caps even though the seller of the debt, a national bank, was exempt from those state law rate caps due to preemption under Section 85 the National Bank Act.  The borrower won on this startling argument and the debt collector appealed to the Supreme Court.  The Office of the Comptroller of the Currency (the regulator for national banks), the U.S. Solicitor General and various stakeholders in the banking and lending industries vigorously argued that the 2nd Circuit’s decision contravened established law.  The fear was that, if preemption strips loans of their usury-exempt status when the loans are sold, then banks’ ability to sell consumer loans, including the common practice of banks originating and quickly selling those loans to investors and marketplace lenders, would be significantly limited, if not curtailed.

The Supreme Court denied the debt collector’s appeal without explanation, which means the 2nd Circuit’s ruling is binding law in that Circuit, which includes New York, Connecticut and Vermont.  However, the 2nd Circuit’s ruling is not the law outside of the 2nd Circuit.

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Should you Buy Loans from “Peer-to-Peer” Lenders?

September 29, 2015

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The market views peer-to-peer lending as having great promise.
And, some banks are buying these loans in earnest.
Should your bank look closely at doing the same?

Since the financial crisis, a new generation of non-bank lenders has grown up to serve markets that banks either retreated from or have not been able to serve effectively.  Lending Club is the best known example.  Prosper is a company that pioneered the term “peer-to-peer” lending and originally saw its role as facilitating the loan of money from ordinary people to ordinary people.

Change happened quickly.  Now, the more fashionable name for companies in this sector is “marketplace lender.”  This term better describes the economics in which a wide array of non-bank lenders make loans in a multiplying array of asset classes and then sell those loans to professional investors.   The share of these loans sold to professional investors is estimated at 80% and growing.  Buyers include asset managers like BlackRock, hedge funds, business development companies, banks and even a specialized mutual fund.  To feed investors’ voracious appetite for these loans, marketplace lenders have expanded beyond their original focus on unsecured personal loans into small-business loans, student loans, real estate loans and an array of other niche loan products, such as financing weddings (and divorces) and point of sale loans, including loans for cars and elective medical procedures.  Most of these lenders rely heavily on technology in the underwriting, documentation and closing of these loans.  Most operate almost exclusively online.

While marketplace lenders pose an immediate threat to some banks, most community banks are not affected from a competitive perspective.  Smaller banks rarely have the ability to make these sorts of loans in a cost-effective manner.  The CRE and C&I loans on which community banks depend are still largely unaffected.  It still requires significant human involvement to underwrite and structure a large commercial loan.

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Regulatory Cleanup in 2015: What Bank Regulations Most Need Reform?

April 22, 2015

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Right now, the federal banking agencies (not including the CFPB) are engaging in a legally-required review process to examine what regulations are outdated, outmoded or unduly burdensome.  Accordingly, the time is especially right for community banks to voice their concerns about their regulatory environment.  Because of their lingering political unpopularity, many banks believe they have little or no leverage to seek reform of counterproductive regulations and improper regulatory enforcement tactics.  But, by speaking with a consistent and united voice and by dealing with facts (in stark contrast to partisan attacks on banks), community banks can achieve real reform.

Here are suggestions for areas in which we can focus our reform efforts, beginning with the most urgent.

1.    Seek genuine “right-sized” bank regulation.  Community banks’ efficiency ratios severely lag those of large banks because the cost of regulation disproportionately burdens community banks.  There is no serious dispute about this by scholars and industry insiders.  Despite many carveouts in Dodd-Frank for sub-$10 billion banks, there still is not a genuine tiering or “right-sizing” of regulation.  Without it, we will see the continued and inevitable disappearance of community banks (over 1,300 so far since 2010) without de novos to replace them. We will continue to see declines in assets held by community banks (at least 12% decline since Dodd-Frank’s enactment).  There are several workable solutions, including the proposal from former FDIC Chairman Sheila Bair to simply give regulators discretion to exempt community banks from unsuitable regulations.  And, many regulators and industry advocates favor defining community bank in terms of its complexity instead of size, which is an eminently sensible proposal.  No one on any point of the political spectrum truly prefers a world dominated by a handful of extremely large banks.  This issue is an urgent matter of survival for the entire community bank industry.

2.    Preserve leadership of prudential banking regulators.  The leading example of abdication by prudential regulators to politically-motivated enforcement is the notorious Operation Choke Point led by the Department of Justice.  That Department has no institutional expertise in banking and makes no pretense of being a prudential regulator, particularly compared to the FDIC, which has decades of cradle-to-grave experience with banks and thoroughly understands the business and regulatory environment in which banks operate.  Even the FDIC appears to have belatedly realized that it was a mistake to concede leadership to the Department of Justice when deciding what sorts of legal bank customers should be denied banking relationships.  It is entirely appropriate for the banking industry to forcefully express its collective expectation that its prudential  regulators must always exert leadership over banking.  This leadership role is best documented by clear, written and published guidance that the prudential banking regulators direct at themselves.  Not only must the banking regulators definitively end Operation Choke Point, banks and their regulators must ensure that they do not abdicate leadership in the future on other banking issues.  Critically important to that goal is ensuring that prudential supervision and compliance enforcement remain at the same agency.  Separating these functions, as is being urged by some, would hardwire the philosophy behind Operation Choke Point into our financial regulatory structure.  Enforcement without the deep understanding acquired over decades by the prudential regulators will lead to banks and their customers being battered by enforcement crusades motivated by political considerations rather than careful analysis.  Bankers and their regulators should unite against any effort to split these functions into separate agencies.  Enforcement unhinged from supervision will dramatically raise compliance and litigation costs for community banks, something a challenged industry cannot afford.

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Can Your Bank Enter the Wealth Management Business?

January 29, 2015

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Have you thought about offering your customers wealth management services? The fee opportunities are attractive and the regulatory issues are more manageable than you might think.

Why should a bank’s board directors consider entering the wealth management business? For one, several of your competitors are already doing so. Wells Fargo already employs over 15,000 financial advisors and is looking to serve an even broader swath of the mass market than it already does. And, according to the American Banker, approximately 25% of all banks plan to offer wealth management services by the end of 2016, according to a survey conducted by that publication. If that survey data is representative across the banking industry, your board would not be in the leading edge if you are not considering the risks and rewards of building or acquiring a wealth management division.

This article assumes that U.S. community banks are not looking to compete directly with the largest private banks in advising billionaires on anything from buying a private jet to investments in complex derivatives. Instead, most community banks will offer basic wealth management services, including administering retirement assets held in 401(k) plans and IRAs, advice in setting up educational and health savings plans and perhaps basic trust services to assist in administering family trusts. Other service offerings, such as insurance, securities custody, securities lending, securities clearing and settlement, are sometimes considered part of wealth management or trust services, but this article does not discuss those other services because they are generally not a good fit for community banks, at least in the early stages of launching a wealth management division. Basic wealth management services are, at least in theory, a natural complement to the business of offering deposit services and loans to wealthier bank customers.

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Negotiating a Mobile Banking Vendor Contract

October 8, 2014

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Adding or upgrading mobile banking is a major project, as is simply changing a bank’s vendor or service provider for mobile banking. This article summarizes the steps involved in doing so.

The banking regulators have all issued guidance on outsourcing activities to third parties. By any measure, a mobile banking service provider is a significant or critical relationship for a bank. The data security demands are significant and the bank is subject to significant strategic, reputation, operational, transaction, and compliance risks, among other risks.

Time may be the single most important consideration. To get the best deal for your bank, start the process of evaluating potential providers, selecting a vendor and negotiation a services agreement 12-18 months before an existing contract is due to renew or before your bank needs to launch a new service.

Due to the significant and high risk nature of mobile banking services, a bank should engage in comprehensive due diligence of its proposed service providers. (And yes, it is recommended that the bank engage in due diligence with more than one service provider, both to ensure it understands the marketplace and also to ensure that it gets a “market” level of service and healthy competition for its business.) Comprehensive due diligence means reviewing financial statements, verifying the vendor’s relevant experience (success in implementing mobile banking for comparable banks) and reputation with comparable banks, the vendor’s regulatory relationships, results of past exams and audits, litigation history, performance issues, data security issues, and consumer complaint history. If the vendor will subcontract or outsource any part of the services, the bank should perform comprehensive due diligence on those subcontractors as well.

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Banks Score Come From Behind Victory on Interchange Fees

March 24, 2014

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In the bankers’ version of March Madness drama, on March 21, 2011, a three judge panel of the U.S. Court of Appeals for the D.C. Circuit handed down a decision that is broadly perceived as a significant victory for banks at the expense of merchants.  (The decision is captioned NACS f/k/a National Association of Convenience Stores, et al. v. Board of Governors of the Federal Reserve System.)

The issue was the legality of the Federal Reserve’s rules implementing the “Durbin Amendment” portion of Dodd-Frank.  That portion of the legislation is generally viewed as having required regulatory caps on the interchange fees that can be charged to merchants.  Merchants criticized the Federal Reserve’s rules for allowing interchange fees at a level much higher than allowed by Dodd-Frank and for allowing interchange competition rules less strict (and thus more favorable to banks) than permitted under Dodd-Frank.  The merchants essentially won this argument at the lower court, the U.S. District Court for the District of Columbia.  The Court of Appeals reversed the district court on all key issues.  The merchants can still appeal the decision to the entire D.C. Circuit appeals court, or to the U.S. Supreme Court.  However, based on our review of this decision, such an appeal appears to have a limited chance of success.  And it seems highly unlikely that either party in Congress is willing to legislate any further on interchange fee issues.

To understand the scope and effect of the decision, a brief review is in order.  The Dodd-Frank Financial Reform Act passed in 2010 included a provision now widely known as the Durbin Amendment, due to its authorship by Illinois Sen. Richard Durbin.  It is widely believed that Senator Durbin authored the provision at the request of the merchant Walgreens, one of his important constituents.  One portion of the Durbin Amendment applies to banks and credit unions with over $10 billion in assets.  For those institutions, the Federal Reserve was required to promulgate regulations to cap interchange or “swipe” fees on debit-card transactions at a level “reasonable and proportional” to the cost the financial institution actually incurs.  Another part of the Durbin Amendment required the Federal Reserve to promulgate regulations to ensure that merchants had at least two unaffiliated networks through which debit card transactions could be routed.

In response to the Durbin Amendment, the Federal Reserve initially proposed capping interchange fees at about $0.12 per transaction.  Then, after considerable study, analysis and uproar from the banking industry that argued with some force that a $0.12 rate would force them to operate at a loss, the Fed’s final regulation capped interchange fees at approximately $0.24 per debit transaction.  The Fed also provided in its final regulations that debit cards may use one PIN debit network and one signature debit network, as long as the two networks were not affiliated.

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SEC Delays Municipal Advisor Registration Rule Through July 1, 2014

January 15, 2014

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The SEC announced on January 13, 2014 that compliance with the final municipal advisor registration rules will be phased in beginning July 1, 2014, notwithstanding that the final rules are effective on January 13, 2014 (following their September 30, 2013 adoption date).  Municipal advisors currently registered under the temporary regime (there are currently about 1,100) are required to register under the permanent regime on a phased-in basis.  As set forth in the table below, a municipal advisor’s temporary registration number determines the applicable compliance period during which the municipal advisor is required to register as such on the final registration forms under the final rules.

Temporary Registration Number Range –>Period for Filing Complete Application for Registration

  • 866-00001-00 through 866-00400-00 –> July 1, 2014 to July 31, 2014
  • 866-00401-00 through 866-00800-00 –> August 1, 2014 to August 31, 2014
  • 866-00801-00 through 866-01200-00 –>September 1, 2014 to September 30, 2014
  • after 866-01200-00 –> October 1, 2014 to October 31, 2014

If a person provides regulated “advice” after January 13, 2014, fits the definition of a municipal advisor, does not qualify for an exemption or exclusion and has not previously registered, then that person must register under the temporary registration rule and then register under the final rules under the above phase-in schedule.  If a person enters the municipal advisory business after October 1, 2014, then the advisor must apply and register under the permanent registration regime.  In any case, an advisor must register before engaging in municipal advisory activities.

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