Financial Services Law

GAO: Virtual Currencies—Emerging Regulatory, Law Enforcement and Consumer Protection Challenges

The Government Accountability Office (GAO) released on June 26 its long-awaited report on virtual currencies undertaken at the request of Senator Tom Carper, chairman of the Senate Committee on Homeland Security & Governmental Affairs. Sen. Carper had asked the GAO to review the potential policy issues surrounding virtual currencies and the status of federal agency collaboration to address such issues.

Providing a good primer on the general legal framework within which virtual currencies operate today, the report addresses the responsibilities of each agency with respect to virtual currencies and the challenges they present for the agency, as well as the actions the agencies have taken in response to virtual currencies and how they are collaborating with other agencies.

Concluding that virtual currencies are technological innovations that present potential risks and benefits for consumers, the report recommends that the Consumer Financial Protection Bureau (CFPB) become more engaged in interagency working groups on the subject. The CFPB, which had an opportunity to comment on the report before its issuance, agreed with the recommendation.

Almost one-quarter of the 56-page report is spent discussing bitcoin and other crypto currencies. The report notes the regulatory, law enforcement and consumer protection challenges presented by such virtual currencies. In particular, it cites potentially greater anonymity of virtual currencies in the absence of a central administrator and their cross-jurisdictional nature as a result of operating on the Internet. Virtual currencies implicate multiple federal agencies, and as a result, addressing these risks will require interagency collaboration and effort. The risks for consumers include 1) lack of bank involvement, and thus none of specific consumer protections such as federal deposit insurance that would be available if a bank were involved; 2) stated limits on financial recourse if a consumer has losses resulting from unauthorized access to the virtual currency account; and 3) volatile prices. On the other hand, virtual currencies offer 1) lower cost, faster transactions because of the lack of an intermediary; 2) financial privacy; and 3) access to populations without access to traditional financial services.

Sen. Carper welcomed the report as “helpful in that it described what the federal government and law enforcement have done and continue to do.” However, Sen. Carper cautioned that the report also raised questions, particularly for the CFPB. Sen. Carper stressed that “all sectors—law enforcement, industry, relevant regulators, and consumer protection agencies—must come to the table and engage in meaningful dialogue to provide clear rules of the road for entrepreneurs, investors, and consumers alike.”

Why it matters: The GAO report presents a reasonably balanced analysis of existing policy concerns with the benefits of virtual currencies for consumers. Although, it provides little new insight into how current laws and regulations are being adapted to virtual currencies. we expect it will cause the CFPB to accelerate its internal timetable for tackling virtual currencies issues and taking a much more active role in addressing consumers protection issues presented by virtual currencies. In fact, even-before the release of the report,- the CFPB had already indicated that it was stepping up its efforts to provide greater guidance on this subject. This report, with two other recently released international reports (OECD and FATF) add to a growing body of governmental or quasi-governmental studies into digital and virtual currencies that are likely to help them gain more mainstream acceptance.

To read the Senate Committee on Homeland Security & Governmental Affair’s article on the report, click here.

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Bank Holding Companies Must Review Their Tax Allocation Agreements With Subsidiary Banks Now!

Taxes remain a certainty in life, but in an effort to reduce confusion regarding the ownership of tax refunds—particularly in light of court opinions reaching varying conclusions when considering failed banks—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency jointly released final supplemental guidance on income tax allocation agreements between holding companies and insured depository institutions.

The regulators last issued an interagency policy statement on the issue in 1998. At that time, the “Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure” established that a holding company that receives a refund from a taxing authority takes the money as an agent for its subsidiary insured depository institutions and other affiliates.

But in the wake of bank failures, courts have struggled with how to allocate refunds for such institutions and reached varying results. Of particular concern for the regulators, some courts have found that tax refunds generated by a failed bank were the property of its holding company, based on a reading of the express language of the tax allocation agreement as creating a debtor-creditor relationship.

Striving for clarity, the new “Addendum to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure” instructs insured depository institutions and holding companies to review (and revise if necessary) their tax allocation agreements to ensure that the documents expressly acknowledge the 1998 policy statement and “do not contain other language to suggest a contrary intent.

All banking organizations should add ownership of tax refund language to clarify their tax allocation agreements, the regulators requested. The Addendum also clarified that tax allocation agreements are subject to the requirements of Section 23B of the Federal Reserve Act (FRA); agreements that do not clearly acknowledge the agency relationship could be subject to additional requirements under Section 23A of the FRA. “Tax allocation agreements should require the holding company to forward promptly any payment due the [insured depository institution] under the tax allocation agreement and specify the timing of such payment,” the Addendum stated.

The regulators provided sample language for tax allocation agreements. Going forward, the agencies said they will deem agreements “that contain this or similar language to acknowledge that an agency relationship exists” for purposes of the policy statement, Addendum, and Sections 23A and 23B of the FRA.

The new guidance should be implemented as soon as possible but no later than Oct. 31, according to the regulators. Notwithstanding this effort by the regulatory agencies, the issue remains contentious in a number of pending cases where the amounts involved are not inconsiderable.

To read the Federal Register Notice about the Addendum, click here.

Why it matters: Holding companies and insured depository institutions have less than four months to review—and revise if necessary—their tax allocation agreements to reflect the requirements of the policy statement and Addendum. Our tax and regulatory attorneys are available to assist with that review and revision.

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Let’s Get Mobile: The CFPB Turns Focus to Mobile Banking

After completing most of its required rulemaking under the Dodd-Frank Act, the Consumer Financial Protection Bureau (CFPB) is now looking at a wide array of consumer financial products and services for additional regulation. One such service is mobile banking.

The CFPB issued a notice last month that it intends to consider both “the opportunities and challenges” associated with mobile financial services (MFS), with an emphasis on the trend’s impact upon the underbanked and underserved population.

Citing statistics that 90 percent of the U.S. population own cellphones—with 60 percent of those owners using smartphones—the agency noted that 74,000 customers per day began using mobile banking services for the first time last year, performing tasks such as checking their account balance, depositing checks and transferring money between accounts. With continuing increases in use and the potential to provide access to banking services for those traditionally shut out, the bureau said it was time to ask some questions about MFS.

In a Request for Information to kick off its review, the CFPB defined MFS “to cover mobile banking services and mobile financial services,” excluding mobile point-of-sale payments, except with respect to mobile payment products that are targeted specifically to low-income and underserved consumers. The bureau asked for comment on the general use of MFS, although the agency is clearly focusing on four specific topics:

  • Unbanked and underbanked. Cellphone use is prevalent among those who operate outside of the banking system, the agency noted, asking if mobile technologies could be a way to expand access to this hard-to-reach population, particularly the younger generation and those with low incomes. Could mobile devices open up options in financial services and money management, and possibly do it more cheaply?
  • Real-time management. Do mobile products and services help consumers manage their money in real time? The bureau cited a recent Federal Reserve study that found 69 percent of mobile banking users checked their account balance before making a large purchase (and half of those decided against buying because of their account balance or credit limit). Can mobile technologies impact spending decisions and are certain products or services more promising than others, the agency queried.
  • Customer service. Mobile financial services may have a negative impact on customer service, presenting greater challenges to access help when an error occurs or a consumer has a question. The CFPB asked for input on what type of technical assistance and/or customer service are available to mobile financial customers. Are additional protections necessary if a device is lost or becomes disconnected from the Internet, the agency questioned, wondering about the need to provide access to a call center at all times for mobile customers.
  • Privacy and data breaches. The bureau recognized that mobile banking presents specific privacy challenges. Consumers need to know what kind of information is being collected about them and how it is being used, the agency said, particularly low-income customers. The CFPB expressed concern that data could be used to direct underserved consumers toward higher-cost products and whether they might be less likely to detect hidden fees. Data breaches are also an issue for MFS, and the Request for Information sought comment on whether breaches are more common on mobile devices as compared to traditional computers.

Comments on the agency’s Request for Information will be accepted until Sept. 9.

To read the Federal Register notice of the Request for Information, click here.

Why it matters: “In a world where people can manage their money on the go, there is great potential to serve more consumers and allow them to take greater control of their finances,” CFPB Director Richard Cordray said in a statement. “But we need to make sure all consumers are protected whether they are opening their wallets or scanning the screen on their smartphones.” Financial institutions and other entities involved in providing MFS should consider responding to the CFPB’s notice to inform the bureau’s likely future rulemaking and reduce the risk that the CFPB will unduly restrict developing MFS services.

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“Next Step” in New York’s Fight Against Payday Lenders: Adding Banks to the Team

Continuing the fight against payday lenders, New York Governor Andrew Cuomo announced the launch of a new database and the cooperation of Bank of America, which will work with the state’s Department of Financial Services (DFS) “to help safeguard New York’s consumers.”

New York’s DFS has been particularly aggressive in its efforts to combat online payday lenders over the past year, with multiple investigations of lenders and the issuance of cease-and-desist letters to 35 lenders making allegedly illegal loans in the state. To bolster its efforts, the regulatory agency recruited its first partners in the private sector in April, when it reached an agreement that Visa and MasterCard would stop lenders from collecting payments via their debit networks.

In the regulator’s latest move, the relationship with Bank of America is based upon a database built by DFS with a list of companies that have been the subject of actions based on evidence of illegal payday lending. Gov. Cuomo called the database “a powerful due diligence tool for financial institutions” and “applaud[ed] Bank of America for stepping up as an industry leader in this area.”

The database—which was built based upon a yearlong investigation by DFS and will be updated on an ongoing basis—will serve multiple functions, including providing an additional resource for financial institutions to meet their “know your customer” obligations. In addition to identifying potential illegal actors, Bank of America said it intends to use the information to confirm that merchant customers are not using accounts to make or collect on illegal payday loans and will contact the lenders’ banks with notification of potentially illegal transactions where necessary.

Bank of America also agreed to provide DFS with information about lenders in the database that are engaged in illegal payday lending activities.

To read the DFS press release about the relationship with Bank of America, click here.

Why it matters: Financial institutions should expect their phones to be ringing soon. Calling Bank of America a “strong example,” DFS Superintendent Benjamin M. Lawsky said his agency “will be reaching out to additional banks asking that they join us in this effort” as the regulator continues its battle against online payday lenders.

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Tribal Immunity at the Supreme Court: Impact on Payday Lenders?

Could a recent Supreme Court decision on tribal sovereignty as it applied to an Indian casino have an impact on payday lenders?

The case itself, Michigan v. Bay Mills Indian Community, involved a casino built by the Bay Mills Tribe, a federally recognized Indian Tribe, off the reservation but on land purchased using monies generated through a congressionally established land trust set up to compensate the Tribe for the takings of its ancestral lands. Bay Mills argued that the property qualified as Indian land and the tribe therefore had the authority to operate a casino there.

The state of Michigan disagreed and sued the tribe under the Indian Gaming Regulatory Act (IGRA) which grants states the power to enjoin “gaming activity on Indian lands and conducted in violation of any Tribal-State compact.” The compact between Bay Mills and Michigan was limited to gaming activity on Indian lands.

In a split decision, a 5 to 4 majority of the Court held that Michigan’s suit was barred by tribal sovereign immunity. Writing for the majority, Justice Elena Kagan revisited the centuries-old doctrine of sovereign immunity as applied by the courts to Indian tribes in the country. The Court has applied such immunity, which the Court held is a necessary corollary to Indian sovereignty and self-governance, whether a suit is brought by a state—like Michigan—or arises from a tribe’s commercial activities off Indian lands, she explained.

Justice Kagan highlighted a 1998 case, Kiowa Tribe of Oklahoma v. Manufacturing Technologies, Inc., where the Court declined to make an exception for suits arising from a tribe’s commercial activities even when they take place off-reservation. Congress has yet to act on the holding in the intervening 16 years, she wrote, lending support to the idea that the legislature supported the justices’ decision.

While Michigan lost the case, the majority suggested a few options for a state to enforce its laws as to off-reservation commercial activities by tribes—notably, focusing on the individuals involved.

For example, Michigan could deny a license for an off-reservation casino, the Court noted, and then bring suit against tribal officials or employees rather than the tribe itself seeking an injunction for gambling without a license. In addition, Michigan could turn to criminal law to prosecute an individual who maintains or frequents an unlawful gambling establishment. “[T]ribal immunity does not bar such a suit for injunctive relief against individuals, including tribal officers responsible for unlawful conduct,” Justice Kagan wrote.

The Court found Michigan’s argument to revisit Kiowa unpersuasive just because tribes are increasingly participating in off-reservation commercial activity.

Importantly for those reading between the lines for application of the decision outside the context of gaming, the justices staked out their relative positions on tribal sovereign immunity in five different opinions. Justice Kagan’s majority opinion emphasized the importance of stare decisis and that the Kiowa decision reaffirmed a long line of precedent concluding that the doctrine of sovereign immunity—without any exceptions for commercial or off-reservation conduct—is settled law. Justice Sonia Sotomayor filed a concurring opinion to speak out against a “commercial activity” exception to tribal sovereign immunity.

But in a dissent authored by Justice Clarence Thomas and joined by Justices Antonin Scalia, Ruth Bader Ginsburg, and Samuel Alito, the minority argued that Kiowa should be overturned by the Court to allow states to take action against tribes engaged in off-reservation commercial activity. One of the examples cited by Justice Thomas of tribes abusing their sovereign immunity: payday lending.

“In the wake of Kiowa, tribal immunity has also been exploited in new areas that are often heavily regulated by states,” Justice Thomas wrote. “For instance, payday lenders (companies that lend consumers short-term advances on paychecks at interest rates that can reach upwards of 1,000 percent per annum) often arrange to share fees or profits with tribes so they can use tribal immunity as a shield for conduct of questionable legality.”

The dissent warned that “[a]s long as tribal immunity remains out of sync with this reality, it will continue to invite problems” and argued that the Court should not wait on Congress to take action on the issue.

To read the Court’s decision in Michigan v. Bay Mills Indian Community, click here.

Why it matters: Courts have struggled with the issue of tribal immunity and off-reservation commercial activity with differing results, and those on both sides of the issue will closely analyze the opinions for support. While the majority upholds the Kiowa decision, four justices made clear their willingness to abrogate tribal sovereign immunity, particularly as it relates to commercial activity off the reservation—with Justice Thomas using payday lending as the primary example of the need to do so. Justice Kagan also set forth several possibilities for regulators other than simply suing a tribe, including filing suit against the individual tribal entities engaging in the activity. Given this “panoply” of possibilities, this dispute could continue in a different forum if the parties are unable to resolve it.

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