DC Court of Appeals Rules CFPB’s Structure is Unconstitutional

Gavel and flag - American justiceOn October 11, 2016, the United States Court of Appeals for the District of Columbia Circuit ruled that the Consumer Financial Protection Bureau’s (CFPB) structure is unconstitutional. PHH Corporation v. Consumer Financial Protection Bureau, No. 15-1177, 2016 WL 5898801 (D.C. Cir. Oct. 11, 2016).

Unlike most independent agencies, which contain multi-member structures to check against arbitrary decision-making and abuse of power, the CFPB is an independent agency lead by a single Director subject only to for-cause removal by the President of the United States under the Dodd-Frank Act. The Court of Appeals observed that this structure “represents a gross departure from settled historical practice,” noting the CFPB’s Director wields “enormous power over American business, American consumers, and the overall U.S. economy.” The court concluded that the CFPB’s structure “poses a greater risk of arbitrary decision-making and abuse of power, and a far greater threat to individual liberty, than does a multi-member independent agency.” Given the CFPB’s unchecked structure, “other than the President, the Director of the CFPB is the single most powerful official in the entire United States Government, at least when measured in terms of unilateral power.”

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Marketplace 2.0

Marketplace LendingOnline marketplace lending platforms are offering compelling new ways for consumers and businesses to obtain loans. Driven by innovations in financial technology (FinTech) that have created dramatic efficiencies, these platforms have changed the face of financial services. According to a KPMG report, the U.S. online alternative finance industry originated $36.4 billion in loans in 2015, up from $11.6 billion in 2014. This segment of the finance industry has obviously been expanding rapidly and we anticipate this expansion will continue.

Just as FinTech has created new online lending models, crowdfunding has created new models for equity investing, donations, and rewards. A 2015 Goldman Sachs report noted that crowdfunding, sourcing funds across a network of supporters, is potentially the most disruptive of all new models in finance.

This blog serves to provide news and commentary on legal and regulatory developments affecting online marketplace funding and crowdsourcing. Particularly as much of the law is evolving rapidly in these emerging areas, and regulators are just now confronting what kind of framework should be put in place, we seek to keep abreast of ongoing developments and let you know about them here and offer practical observations.

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Kicking the Can Down the Road: SCOTUS Denies Petition to Madden v. Midland Funding

On June 27, 2016, the Supreme Court denied certiorari in Madden v. Midland Funding. The decision is unsettling for the banking and marketplace lending industries, which had hoped the Supreme Court would seize the opportunity to reverse the Second Circuit’s controversial holding. As a result of the denial, secondary (non-bank) debt purchasers operating within the Second Circuit are ostensibly prohibited from collecting interest charges in excess of state usury caps – a practice that traditionally had not been an issue as long as the interest charges were permissible under the original loan agreements.

The Solicitor General and the OCC had argued in a brief to the Supreme Court that the Second Circuit clearly misunderstood the underlying law. Despite heavily criticizing the Second Circuit’s reasoning, the Solicitor General recommended that the Supreme Court deny certiorari primarily because there was no actual circuit split and the defendant could succeed based on a choice-of-law question on remand. The Supreme Court likely relied heavily on the Solicitor General’s brief when making its decision. Some commentators have speculated that the Court simply decided to wait to address the issue until after Antonin Scalia’s vacancy has been filled.

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Financial Services Roundtable Creates FinTech Collaboration Program

The Financial Services Roundtable, a leading financial services trade association that represents the interests of the top banks and other large financial institutions in the country, announced this week a new Tech Collaboration Program to bring together leaders from financial technology companies (“FinTech”) and traditional financial institutions. The program is intended to help FinTech and financial institutions work cooperatively together to develop best practices and guidelines to improve security, efficiency and to better meet consumer demand for financial services.

The program reflects a friendlier approach to FinTech from the financial services industry. Banking leaders elsewhere have expressed dissatisfaction that FinTech lacks proper federal regulation and oversight and could put consumers at risk. The Financial Services Roundtable’s program suggests that cooperation may be a way to address those concerns.

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CFPB Proposes Ban on Class Action Waiver Provisions in Arbitration Agreements

Law gavel on a stack of American moneyOn May 5, 2016, the Consumer Financial Protection Bureau (CFPB) announced proposed regulations that would prohibit financial service providers from using arbitration clauses that prevent consumers from bringing class action lawsuits. Under the CFPB’s proposal, companies would still be able to include arbitration clauses in their contracts, but the clauses would be required to expressly state that they cannot be used to prevent consumers from being part of a class action lawsuit.

In addition to the ban on class action waivers in consumer arbitration agreements, the proposed regulations would require companies that arbitrate disputes with consumers to submit information regarding arbitration claims, awards and related materials to the CFPB. The CFPB says that it will use this information to monitor arbitration proceedings to assess the necessity of increased future oversight.

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SCOTUS’ Spokeo Decision Limits Consumer Credit Class Actions

Spokeo Inc v. RobinsLast week, the U.S. Supreme Court handed a temporary victory to a “people search” website, when it remanded a closely watched case to the Ninth Circuit for further proceedings.

The case, Spokeo, Inc. v. Robins, is a consumer credit protection class action brought under the federal Fair Credit Reporting Act (FCRA). The case is of interest to the marketplace lending industry, which is subject to the multitude of federal consumer credit protection laws, such as the FCRA.

Spokeo is a people search engine that organizes people’s online information into data profiles for various users, including “employers who want to evaluate prospective employees,” or “those who want to investigate prospective romantic partners or seek other personal information.”  At issue in the case are Spokeo’s procedures for making sure those profiles are accurate.

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OCC Signals Support for FinTech Innovations

FinTech InnovationsThe federal banking agency that supervises national banks and federal savings associations – the Office of the Comptroller of the Currency (“OCC”) – has formally taken up financial technology (“FinTech”) as an important regulatory issue. In a white paper released on March 30th, the OCC outlines principles that the OCC will follow in its approach to regulating FinTech. The white paper reflects the OCC’s desire to work with banks and FinTech firms to foster the responsible development of FinTech innovations. The white paper seeks public comment on issues raised in the paper by May 31st.

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Online Lender Fined for Requiring Repayment by AutoPay

Online LendingIn a March 16th decision, a federal magistrate judge in California ordered a lender to pay $500,000 in statutory damages under the Electronic Funds Transfer Act (“EFTA”) for conditioning online loans on borrowers’ agreements to repay such loans through automatic electronic funds transfers. Under the EFTA (15 U.S.C. §1693k), a lender may not condition an extension of credit on a consumer’s repayment by means of preauthorized electronic fund transfers (“EFTs”). The opinion in the case, Kempley v. Cashcall, Inc., notes that this is apparently the first court since the EFTA’s enactment to apply the EFTA’s civil damages provision in connection with a violation of this prohibition.

The online lender in the case made loans to high-risk borrowers. The lender required such borrowers to check a box as part of the online loan application process to authorize automatic preauthorized payments from their bank accounts to repay the loans. The borrowers successfully argued that this practice violated the EFTA’s prohibition on conditioning a loan on repayment by EFTs. The court imposed the maximum statutory penalty of $500,000 in connection with a class action for a violation of the EFTA.

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SCOTUS Raises the Stakes in Madden v. Midland Funding

United States Supreme Court BuildingThe Supreme Court recently “raised the stakes” concerning its potential review of a significant ruling of the Second Circuit by asking the Obama Administration whether the Supreme Court should review the case. The Obama Administration’s recommendation could potentially nudge the Court into reviewing the significant case that could permanently alter the national marketplace lending industry moving forward by jeopardizing a prevalent funding model used in the industry.

The matter, Madden v. Midland Funding, concerns the current bank-partnership model that many marketplace or alternative lenders use to avoid compliance with individual states’ usury laws and interest-rate caps. The Second Circuit, in the underlying matter involving the sale of charged-off credit card debt by a major national bank’s subsidiary, barred the transfer to the debt buyer of the bank’s authority to charge interest rates in excess of state usury caps. The decision in May 2015 created significant uncertainty for the sustainability of marketplace lending models.

Marketplace lenders have created sustainable bank-partnership models by taking advantage of an originating bank’s interest rate exportation authority. Under this, a bank may export the favorable interest rate authority from the state in which the bank is located—for example, Utah—to consumers residing in other states. Marketplace lenders can export these higher interest rates and avoid state-by-state usury laws that would otherwise cap the interest rates marketplace lenders could charge consumers. National banks are exempt from state interest rate caps, while many nonbank financial services companies—including marketplace lenders—are not. Hence, marketplace lenders rely on an originating bank’s ability to export interest rates, the very substance of which Midland Funding has called into question.

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The Perils of Success: Recent Regulatory Focus Heightens Potential For Future Risk

Marketplace LendingTwo recent regulatory actions – one by the Consumer Financial Protection Bureau, the other by the California Department of Business Oversight – highlight the increased scrutiny facing marketplace lenders from a consumer protection perspective. Companies involved in the marketplace lending industry will likely face additional regulatory inquiries and heightened scrutiny throughout the remainder of 2016, as the industry’s relationship with government regulators on all levels continues to evolve. As marketplace lenders continue to generate greater interest from both consumers and traditional financial services companies, so too will these lenders face rising regulatory risks.

CFPB Inquiry
Earlier this month, the CFPB announced it would start accepting consumer complaints concerning marketplace lending for inclusion in its database. To this point, the CFPB had not said what steps—if any—it might take to regulate the marketplace lending industry. In conjunction with this announcement, the CFPB also released a consumer bulletin outlining information the agency considers important for consumers interested in securing a marketplace loan. In the press release, CFPB Director Richard Cordray stated that the Bureau required all marketplace lenders comply with existing rules. The consumer bulletin in particular highlighted potential concern for consumers who could lose legal protections by refinancing debt with a marketplace lender.

The CFPB’s announcement is the second federal regulatory inquiry of the marketplace lending inquiry, following a July 2015 inquiry from the Department of the Treasury. The Department issued a public request for information from industry leaders, consumer protection groups, and other related persons about the recommendations for future regulation of the industry, along with information about marketplace lending business models prevalent in the industry. The Department also acknowledged the potential overlap of regulatory authority between it and the CFPB in the RFI.

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