Financial Services Law

Treasury Department: Tell Us More About Online Marketplace Lending

Why it matters

Raising the possibility of regulation, the Department of the Treasury has published a Request for Information (RFI) regarding online marketplace lending (also called peer-to-peer lending), seeking public comment on the various business models and products offered by such lenders to both small businesses and consumers, the potential for the market to expand access to credit to historically underserved segments, and how the regulatory framework should evolve to support the "safe growth" of the industry. The Treasury also asked for information on the customer acquisition process—What kind of marketing is used? Are relationships with traditional financial institutions leveraged?—and input on the balance of how the use of electronic data can help automate processes and decrease costs but presents risks not found in traditional lending. The comment period for the "Public Input on Expanding Access to Credit Through Online Marketplace Lending" RFI will be open until the end of August, providing stakeholders with the opportunity to weigh in on the fast-growing industry, a topic that looks to be the subject of future regulation by the Treasury. Although the questions suggest that the Treasury generally has a favorable view of marketplace lending, this Treasury initiative will draw the attention of other regulators, and likely is the beginning of significantly greater regulation of the online marketplace lending industry.

Detailed discussion

Could increased regulation of online marketplace lenders be on the horizon? A new Request for Information (RFI) issued by the Department of the Treasury could signal the agency's interest, given the wide-ranging scope of its inquiry.

Defining "online marketplace lending" as "the segment of the financial services industry that uses investment capital and data-driven online platforms to lend to small businesses and consumers," the Treasury focused the RFI on three topics: the various business models and products offered by online marketplace lenders to consumers as well as small businesses; the potential for such lending to expand access to credit to underserved market segments; and how the regulatory framework should evolve to support the "safe growth" of the industry.

The Treasury acknowledged the value of online marketplace lending, which "has filled a need" for borrowers facing barriers to access to affordable credit from traditional lenders. Online marketplace lenders are developing product structures and underwriting models that make loans to non-prime borrowers and small businesses possible at lower rates and with reduced transaction costs, offering a new source of financing for historically underserved markets, the RFI noted.

Why take a closer look at online marketplace lending now? Although it remains "a very small component" of the lending market, "it is a rapidly developing and fast-growing sector that is changing the credit marketplace," the Treasury explained. "In less than a decade, online marketplace lending has grown to an estimated $12 billion in new loan originations in 2014, the majority of which is consumer lending."

The RFI identified three types of companies operating in the industry: balance sheet lenders that retain credit risk in their own portfolios and are typically funded by venture capital, hedge fund, or family office investments; online platforms that sell securities to obtain financing to enable third parties to fund borrowers and do not retain credit risk; and bank-affiliated online lenders funded by a commercial bank, often a regional or community bank, that originate loans and directly assume the credit risk.

Some of the companies also partner with banks, the Treasury said, where the bank acts as the lender to borrowers that apply on the platform and the loans are sold to second-party investors or the marketplace lender. Despite the different business models, online marketplace lenders have several similarities, including providing funding through online loan applications, operating without retail locations, using electronic data sources and technology-enabled underwriting models to determine a borrower's credit risk, and providing faster access to credit.

Given all of these different business models and types of lenders, how should policymakers be thinking about market segmentation, the Treasury wondered, and in what ways do different models raise different policy or regulatory concerns? Are lenders designing their models and products for different borrower segments (consumers or small businesses, for example, or even more specifically, new small businesses or consumers seeking to consolidate existing debt)?

Significantly, the RFI also sought details on whether platform lenders should be required to have "skin in the game" for the loans they originate or underwrite as well as more information on investors, such as their operational arrangements and methods of finance.

The use of electronic data helps online marketplace lenders automate their processes and decrease the costs passed on to borrowers. But what role do all of the electronic data sources play in issues such as the evaluation of identity, fraud, and credit risk for lenders, and do the data-based processes create new opportunities or risks not found in traditional lending, the RFI asked.

A key line of inquiry for the Treasury: whether online marketplace lending is expanding access to credit for historically underserved market segments. Additional questions in the RFI explored the customer acquisition process, such as marketing used to reach new customers and partnerships with traditional financial institutions, community development financial institutions, or other types of businesses.

While online marketplace lending offers "significant benefits and value to borrowers," the RFI questioned whether harms might also be present—such as privacy considerations, cybersecurity threats, consumer protection concerns, or other related risks—and if existing statutory and regulatory regimes sufficiently address these issues.

The RFI also requested information on how borrowers are assessed for their creditworthiness and repayment ability. "How accurate are these models in predicting credit risk? How does the assessment of small business borrowers differ from consumer borrowers?" the Treasury asked.

Some online marketplace lenders may be subject to existing regulations promulgated by the Federal Trade Commission or the Consumer Financial Protection Bureau, the RFI noted, and relationships with traditional financial lending institutions may also trigger regulatory oversight. Have participants in the new industry taken any steps toward compliance and what issues are raised with online marketplace lending across state lines?

Those commenting on the RFI could also discuss how marketplace lenders manage operational practices (loan servicing, fraud detection, and credit reporting, for example) and how such practices may differ from those at traditional lending institutions, including any tasks outsourced to third-party service providers.

Speaking of banks, the Treasury sought information on the advantages and disadvantages of their participation in the market and how changes in the credit environment might impact online marketplace lenders. Does a secondary market currently exist, and what are the advantages and disadvantages of such a market, the RFI asked.

Finally, the RFI concluded with a catchall question, asking what "other key trends and issues" policymakers should be monitoring as the market continues to develop.

Comments will be accepted until August 31.

To read the Department of the Treasury's RFI, click here.

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CFPB Releases Principles for Payment Systems

Why it matters

In an effort to provide guidance to payment systems looking to reduce "pocket-to-pocket" payment times, the Consumer Financial Protection Bureau (CFPB) released principles for consumer protection to ensure that the systems are "secure, transparent, accessible, and affordable to consumers," and contain "robust protections when it comes to fraud and error resolution." As companies develop real-time or near real-time payment systems, the Bureau emphasized that consumer protections should be built in from the start to avoid "retrofitting" later on. The agency set forth nine principles for new and faster systems, touching upon issues such as consumer control, data protection, affordable cost, and accountability mechanisms. While the CFPB has previously advocated for the development of faster and safer consumer payment capabilities, as "faster payments could enable faster, safer, and more accessible commerce," the new guidance could indicate the Bureau's intent to exercise its ever-expanding jurisdiction in the payment system ecosystem.

Detailed discussion

In the never-ending quest to make financial transactions fast and even faster, payment systems are striving to achieve real-time—or as close to real-time as possible—transfers. The Consumer Financial Protection Bureau (CFPB) decided to offer some guidance to entities in the hope of encouraging consumer protections to be included at the outset, rather than having to take action in the years to come.

"The CFPB wants to ensure any new payment systems are secure, transparent, accessible, and affordable to consumers," the Bureau explained in a statement. "The systems should also have robust protections when it comes to fraud and error resolution."

The participants in the payment system—operators, institutions, providers, payees, and payers—are all subject to various rules and regulations, from the Electronic Fund Transfer Act to operator-specific rules for banks that connect and use the networks.

As the industry continues to change, the CFPB "wants to ensure that consumer protections are at the forefront as new and improved payment systems are developed," the Bureau said. The agency said it intends to work with other regulators—such as the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the National Credit Union Administration, the Federal Trade Commission, and state banking commissions—to encourage development of faster and safer consumer payment capabilities, ensuring that "new payment systems address consumer needs and interests."

Nine principles made up the CFPB's guidance. First, consumers should be able to exercise control over their payments, the Bureau said. Each payment should align with what the consumer has authorized, with system parameters allowing a consumer to limit the time period an authorization is valid, as well as the amount and the payee, and specific procedures to "easily" revoke authorization.

Information about data and privacy should be provided to consumers, including what data are being transferred, who has access, and the potential risks, the CFPB advised in its second principle. When data is collected, it should only be used in ways that benefit consumers and "[a]s appropriate," systems should allow consumers to specify what data can be transferred and if third parties can have access.

The third principle focused on fraud and error resolution protections. Systems should provide mechanisms for reversing erroneous and unauthorized transactions "quickly" once identified, the Bureau said, and ensure the application of regulatory safeguards such as Regulation E and Regulation Z. Transparency—timely disclosure of the costs, risks, funds availability, and security of payments—should also include real-time access about the status of transactions, according to the fourth principle.

In the fifth principle, the CFPB said systems should be affordable to consumers. Disclosure of fees should occur in a manner that permits consumers to comparison shop among the different available payment options, the agency added.

"Any new faster system is broadly accessible to consumers," the Bureau wrote in principle six. Access through qualified intermediaries, such as mobile wallet providers and payments providers, should be allowed, with limits where necessary "to protect functionality, security, or other key user values."

Addressing funds availability, principle seven argued that consumers are the primary beneficiaries of faster clearing and settlement available in the new payments systems, providing guaranteed access to funds and decreasing the risk of overdraft and declined transactions.

Systems should have "strong built-in protections to detect and limit errors, unauthorized transactions, and fraud," according to principle eight, providing safeguards against and responding to data breaches. Credential value limits may also be considered using tokenization or other tools, the CFPB said.

Finally, principle nine: strong accountability mechanisms that effectively curtail system misuse. Commercial participants are the responsible parties for the risks, harm, and costs they introduce to payment systems, the guidance said, and should make use of automated monitoring capabilities, incentives for participants to report misuse, and transparent enforcement procedures.

The Bureau noted that it was not specifying how the principles must be achieved, recognizing "that a variety of system components, including system architecture, operator covenants and warranties, requirements for participants and intermediaries, rules, and other mechanisms may play critical roles in providing consumer protection, utility, and value."

To read the CFPB's Consumer Protection Principles, click here.

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DOJ Report Clears Agency From Unlawful Behavior Charges in Operation Choke Point

Why it matters

A new report from the Department of Justice's (DOJ) Office of Professional Responsibility (OPR) found that agency attorneys did not engage in professional misconduct by improperly targeting objectionable businesses or industries under Operation Choke Point. The report was the result of a request from Sen. Blaine Luetkemeyer (R-Mo.) and more than 30 other lawmakers after a staff report from the House Oversight and Government Reform Committee, The Department of Justice's "Operation Choke Point": Illegally Choking Off Legitimate Businesses? stated that the DOJ unlawfully targeted Internet payday lenders and then pressured banks not to do business with them. In a counterpoint, the DOJ report found that "[n]either the design nor the initial implementation of Operation Choke Point specifically focused on Internet payday lenders or their lending practices," although some DOJ attorneys viewed payday lending "in a negative light." No evidence was found of efforts by the DOJ to improperly pressure lawful businesses, the report said, that lawyers in the agency provided inaccurate information to Congress, or that Operation Choke Point compelled banks to terminate relationships with lawful businesses. Notably, in the report OPR did not evaluate whether Operation Choke Point was a worthwhile initiative for the DOJ to undertake.

Detailed discussion

The DOJ has touted successes against banks, including relating to third-party payment processors conducting unauthorized withdrawals from consumer accounts, but critics have charged the DOJ with unfairly targeting the payday lending industry and improperly leaning on banks to cut ties with objectionable businesses. Rep. Blaine Luetkemeyer (R-Mo.) even introduced federal legislation, the "End Operation Choke Point Act," to place limits on the DOJ's subpoena power and formally prohibit regulators from restricting or discouraging financial institutions from dealing with lawful businesses.

In May 2014, the House Oversight and Government Reform Committee released a staff report that accused the Justice Department of using Operation Choke Point to eliminate industries it deemed unacceptable. The report (The Department of Justice's "Operation Choke Point": Illegally Choking Off Legitimate Businesses?) triggered Rep. Luetkemeyer and more than 30 other legislators to request a report from the DOJ in response.

Examining the assertions raised in the staff report and levied by critics of Operation Choke Point, the DOJ's Office of Professional Responsibility (OPR) reached a contrary conclusion.

"Neither the design nor the initial implementation of Operation Choke Point specifically focused on Internet payday lenders or their lending practices," the OPR found. None of the individuals involved in the operation committed professional misconduct, abused their authority, or improperly targeted objectionable industries or businesses, the report stated.

The OPR reviewed thousands of pages of internal Department documents, the subpoenas issued by the agency pursuant to the Financial Institutions Reform and Recovery Act (FIRREA), case-related memoranda and documents, and the e-mail records and detailed written responses from the attorneys most involved in the implementation of the operation. Also considered: the FIRREA statute, its legislative history, related case law, academic commentary, the House Committee's staff report, and applicable standards of conduct.

While OPR found that the DOJ attorneys did not engage in professional misconduct, the report acknowledged that "some of the congressional and industry concerns relating to Internet payday lending was understandable." Some memoranda reviewed by the OPR "discussed and at times seemed to disparage payday lending practices" for reasons unrelated to FIRREA, the report stated. And some e-mails corroborated the finding that certain attorneys in the Civil Division's Consumer Protection Branch working on Operation Choke Point "may have viewed Internet payday lending in a negative light."

Despite this evidence, "the relatively few Operation Choke Point subpoenas related to Internet payday lending were well supported by facts showing that the targets of the subpoenas allegedly were involved in mass-market fraud schemes," according to the OPR report.

Examining the agency's use of its subpoena power under FIRREA, the DOJ report found it was supported by current case law. A total of sixty subpoenas were issued by the Justice Department as part of Operation Choke Point with "relatively few related in any way" to Internet payday lending, the report said. "Of that number, it appears that the Civil Division had specific and articulable evidence of consumer fraud for each subpoena it issued. To the extent that Civil Division attorneys involved in Operation Choke Point investigated Internet payday lending, their focus appeared to be on only a small number of lenders they had reason to suspect were engaged in fraudulent practices."

In addition, all three of the cases filed under Operation Choke Point were resolved by negotiated settlements and consent judgments that were approved by federal courts, the OPR report pointed out.

According to the report, the evidence also failed to support the concern that DOJ attorneys issued FIRREA subpoenas in an effort to compel banks to terminate legitimate business relationships.

"Indeed, in all the Civil Division memoranda, subpoenas, and contemporaneous e-mails OPR reviewed, OPR did not find evidence of an effort to improperly pressure lawful businesses," the report said. "Although Civil Division attorneys at one point did enclose with issued FIRREA subpoenas regulatory guidance from federal regulators, including one document that contained a footnote listing businesses that the [Federal Deposit Insurance Corporation] had described as posing an 'elevated risk,' OPR's inquiry revealed that the attorneys had a legitimate reason for including such regulatory guidance."

The OPR was also unable to find evidence to support the idea that DOJ attorneys provided inaccurate information to Congress about "the design, focus, or implementation" of Operation Choke Point. The Justice Department's "focus was on fraud, and not an entire industry," the report concluded.

To read the OPR Inquiry Regarding Operation Choke Point report, click here.

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Less Harsh, for Weed: New Bill Would Help Banks Work With Marijuana Businesses

Why it matters

A new bill introduced in Congress would help legal marijuana businesses access much-needed financial services. Banks have struggled with the question of whether—and how—to work with marijuana-related businesses. The Marijuana Businesses Access to Banking Act of 2015 would improve the situation, banning regulators from penalizing banks or taking other actions against financial institutions that offer accounts to marijuana shops or dispensaries in the states where use of the drug is legal. Co-sponsor Cory Gardner (R-Colo.) called the statute a "commonsense" solution to a major problem for marijuana-related businesses working with a high volume of cash and facing challenges paying taxes and handling payroll. Although the Financial Crimes Enforcement Network (FinCEN) released guidance in February 2014 ostensibly to encourage financial institutions to provide banking services to marijuana-related businesses, Sen. Gardner and his co-sponsors said the new bill is necessary because FinCEN's guidance was insufficient to alleviate the concern of financial institutions and the potential for liability.

Detailed discussion

As the number of states that have legalized marijuana—the medicinal use of pot is legal in 23 states with recreational use decriminalized in four states and Washington, D.C.—has risen over the years, businesses have sprouted up to take advantage of the new market.

However, the businesses have faced an obstacle unique to the marijuana industry: a lack of access to financial institutions. Concerned about the reaction of federal regulators to working with marijuana-related businesses, banks have been hesitant to offer accounts or encourage relationships, despite the burgeoning marketplace.

Marijuana remains illegal under federal law as well as the majority of states, and banks are prohibited from knowingly providing services to illegal enterprises. In February 2014, the Department of Justice and the Financial Crimes Enforcement Network (FinCEN) released guidance on how to work with marijuana-related businesses.

Although the regulator's stated intent was to help banks work with marijuana-related businesses, the guidance made clear that financial institutions are still required to file Suspicious Activity Reports on transactions involving the proceeds of marijuana sales consistent with Bank Secrecy Act obligations. The guidance also drew criticism from Sens. Dianne Feinstein (D-Cal.) and Charles Grassley (R-Iowa), with the lawmakers asserting that the guidance would actually assist businesses attempting to inject the proceeds of criminal activity into the nation's financial system.

One of the first states to legalize marijuana for medical use, Colorado stepped up earlier this year to enact the first state law establishing a financial system for marijuana-related businesses. Washington followed.

But a group of lawmakers—Sens. Cory Gardner (R-Colo.), Michael Bennet (D-Colo.), Ron Wyden (D-Ore.), Jeff Merkley (D-Ore.), Patty Murray (D-Wash.), and Rand Paul (R-Ken.)—said more action from the federal government is necessary to protect banks, introducing the Marijuana Businesses Access to Banking Act of 2015.

"Ever since Colorado voters approved the legalization of recreational marijuana, conflicting federal and state marijuana laws have required banks to refuse basic financial services to marijuana-related businesses in Colorado," Sen. Gardner said in a statement. "This commonsense legislation solves a major public safety problem in my state by giving legitimate businesses acting in compliance with state laws access to the banking system."

Pursuant to the act, federal banking regulators would not be able to "prohibit, penalize, or otherwise discourage a depository institution from providing financial services to a marijuana-related legitimate business." In addition, regulators would be barred from terminating or limiting access to federal deposit insurance for financial institutions that issue accounts to registered marijuana shops.

Depository institutions would be protected from federal regulators that try to "recommend, incentivize, or encourage" the bank not to offer financial services to an individual solely because of their ownership or operation of a legal marijuana-related business. And regulators would be prohibited from taking "any adverse or corrective supervisory action" on a loan to the owner or operator of legitimate marijuana-related businesses.

S.1726 would also create a safe harbor for financial institutions that provide services to marijuana-related businesses operating legally from liability under any federal law or regulation solely for providing the financial services or further investing any income derived from the financial services.

The bill is currently pending before the Senate Committee on Banking, Housing, and Urban Affairs.

To read the Marijuana Businesses Access to Banking Act of 2015, click here.

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