The 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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Two 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.
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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The concept of “crowdfunding” offers a new option to startups and small businesses for raising capital, although it is a greatly misunderstood and misused term. It refers to the pooling of money from a crowd for the funding of a project or venture, whether utilizing a donation model, reward model, royalty model, debt model or equity model. Securities laws apply when equity or debt securities are offered.
Title III of the JOBS Act added a new Section 4(a)(6) to the Securities Act, which provides an exemption from the registration of such securities provided the issuer complies with certain rules and restrictions. To implement this amendment, federal crowdfunding rules were enacted by the SEC on October 30, 2015 as Regulation Crowdfunding. The rules are expected to become effective on May 16, 2016.
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