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.

The CFPB has maintained a Complaint Database since 2011 of more than 530,000 complaints concerning a range of consumer financial products and services. The Database includes anonymous information about each individual complaint received, including customer-specific information such as the customer’s zip code, the relevant company, and product type. The CFPB sends all customer complaints directly to the relevant company and asks for a reply; the Database includes both the issue about which the customer has complained, as well as the relevant company’s response. The CFPB likely will use these customer complaints to identify potential bad actors in the industry, as well as base future enforcement activity and rulemaking decisions on them.

At first blush, the CFPB’s decision to accept consumer complaints concerning marketplace lending is significant. It signals a likely pivot towards adopting more stringent regulation of the industry in the near future, although jurisdiction over the marketplace lending industry remains unclear between the CFPB and the Department of the Treasury/Securities and Exchange Commission. CFPB’s actions should clearly serve as a warning to the growing marketplace lending industry that the industry now has CFPB’s focus and could be subject to future intense scrutiny and regulation, which could increase compliance costs. The CFPB has broad regulatory authority governing standards that apply to a variety of consumer loans within the marketplace lending industry, and can enforce that authority through both applicable statutes and regulations as well as the Bureau’s broader authority to regulate general unfair, deceptive or abusive practices in the broader consumer financial services industry. Of all potential federal regulators, the CFPB is perhaps the best-positioned agency to exercise significant—and potentially disruptive—regulatory authority over the growing marketplace industry.

California Department of Business Oversight Inquiry
In December, the California Department of Business Oversight (“DBO”) announced a statewide inquiry into the marketplace lending industry. DBO Commissioner Jan Lynn Owen stated the purpose of the inquiry was to “protect” consumers:

“These online lenders are filling a need in today’s economy, and we have no desire to squelch the industry or innovation. We have a duty, however, to protect California consumers and businesses, and they have more and more at stake as this industry grows. We want to assess the effectiveness and proper scope of our licensing and regulatory structure as it relates to these lenders.”

California-CourtsUnder California law, the DBO licenses and regulates a broad scope of financial service providers that potentially involve marketplace lending, including state-chartered banks and credit unions, non-bank lenders, mortgage lenders and servicers, investment adviser, and broker-dealers.

As part of the inquiry, the DBO sent fourteen marketplace lenders a survey that sought five-year loan trend data both nationally and within California on the following data points: the overall numbers and size of the lenders’ loan portfolios; APR data for the portfolios; delinquency statistics; and investor funding information. The DBO also asked the lenders for descriptions of their business models, such as whether originations occurred through an online platform and whether the lenders retained any interest in loans the lenders originated, as well as descriptions of the lenders’ platforms. The DBO’s requests also asked for specifics concerning each lenders’ underwriting processes, borrower verification, and the role underwriting banks play in the origination process. The DBO specifically requested information targeting each lenders’ personal and business loan origination platforms.

The DBO has not stated its intentions for use of the data sought from the selected marketplace lenders. However, state regulators such as the DBO often supervise nonbank financial service providers that fall outside the scope of federal regulators, and many have the ability to enforce state usury, debt collection and advertising laws for consumer financial services products through the states’ attorneys general. Certain state regulators and enforcement officers may also have the ability to create regulatory risk for marketplace lenders by enforcing existing state Blue Sky laws if marketplace lenders offer public offerings of their notes.

Given DBO’s focus and the general increase in interest in the industry, marketplace lenders will likely face a significant increase in state regulatory focus on the industry as more consumers opt for marketplace lending products. To meet this advancing challenge, marketplace lenders should ensure compliance with all state licensing and advertising requirements, as well as potential funding challenges posed by a focus on enforcement of state usury laws.

Patrick McDonough

About: Patrick McDonough

Patrick works on a broad spectrum of commercial and civil matters. Prior to joining LeClairRyan, he served as the Judicial Law Clerk to the Honorable William J. Meade of the Massachusetts Appeals Court, where he gained extensive experience in legal writing and decision-making while becoming familiar with appellate practice in Massachusetts. View all posts by Patrick McDonough
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