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On July 11, the New York Department of Financial Services (NYDFS or the Department) released a study of online lending in New York, as required by AB 8938. (Previously covered by InfoBytes here.) In addition to reporting the results of its survey of institutions believed to be engaging in online lending activities in New York, NYDFS makes a series of recommendations that would expand the application of New York usury and other statutes and regulations to online loans made to New York residents, including loans made through partnerships between online lender and banks where, in the Department’s view, the online lender is the “true lender.”
In particular, NYDFS recommends, “[a]ll New York lenders should operate under the same set of rules and be subject to consistent enforcement of those rules to achieve a level playing field for all market participants….” Elsewhere in the report, the Department states that it “disagrees with [the] position” that online lenders are exempt from New York law if they partner with a federally-chartered or FDIC-insured bank that extends credit to New York residents. NYDFS criticizes these arrangements, stating its view that “the online lender is, in many cases, the true lender” because the online lender is “typically … the entity that is engaged in marketing, solicitation, and processing of applications, and dealing with the applicants” and may also purchase, resell, and/or service the loan.
NYDFS also noted that it opposed pending federal legislation that would reverse the Second Circuit’s decision in Madden v. Midland Funding, LLC, which held that federal preemption of New York’s usury laws ceased to apply when a loan was transferred from a national bank to a non-bank. The Department expressed concern that, if passed, the bill “could result in ‘rent-a-bank charter’ arrangements between banks and online lender that are designed to circumvent state licensing and usury laws.”
Noting that many online lenders remain unlicensed in New York, the Department states that “[d]irect supervision and oversight is the only way to ensure that New York’s consumers and small business owners receive the same protections irrespective of the channel of delivery….” To this end, NYDFS recommended lowering the interest rate threshold for licensure from 16 percent to 7 percent.
Although NYDFS stressed that its survey results may be unreliable due to uneven response rates, it reported that, for respondents, the average median APR for online loans to businesses was 25.9%, the average median APR for online loans to individuals for personal use was 14.8%, and the average median APR for the underbanked customers was 19.6% (New York currently caps interest for civil liability at 16% and at 25% for criminal liability).
Overall, the report appears to forecast a more difficult regulatory and enforcement environment in New York for online lenders, as has been the case in West Virginia and Colorado.
On June 27, the Colorado and New York Attorneys General led a coalition of 21 state Attorneys General in a letter to congressional leaders opposing HR 3299 (“Protecting Consumers’ Access to Credit Act of 2017”) and HR 4439 (“Modernizing Credit Opportunities Act”), which would effectively overturn the 2015 decision in Madden v. Midland Funding, LLC. Specifically, H.R. 3299 and H.R. 4439 would codify the “valid-when-made” doctrine and ensure that a bank loan that was valid as to its maximum rate of interest in accordance with federal law at the time the loan was made shall remain valid with respect to that rate, regardless of whether the bank subsequently sells or assigns the loan to a third party.
The letter argues that the legislation “would legitimize the efforts of some non-bank lenders to circumvent state usury law” and it was not Congress’ intention to authorize these arrangements with the creation of the National Bank Act. In support of their position, the Attorneys General cite to a 2002 press release by the OCC and the more recent OCC Bulletin 2018-14 on small dollar lending, which stated the agency “views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).” (Previously covered by InfoBytes here.) The letter also refers to an 1833 Supreme Court case, Nichols v. Fearson, which held that a “valid loan is not invalidated by a later usurious transaction involving that loan” but was not relevant to the decision in Madden because the borrower’s argument related to preemption. Ultimately, the Attorneys General conclude the legislation would erode an “important sphere of state regulation” as state usury laws have “long served an important consumer protection function in America.”
House passes bill that would effectively overturn Madden; others amend RESPA disclosure requirements and adjust points and fees definitions under TILA
On February 14, in a bipartisan vote of 245-171, the House passed H.R. 3299, the “Protecting Consumers Access to Credit Act of 2017,” to codify the “valid-when-made” doctrine and ensure that a bank loan that was valid as to its maximum rate of interest in accordance with federal law at the time the loan was made shall remain valid with respect to that rate, regardless of whether the bank subsequently sells or assigns the loan to a third party. As previously covered in InfoBytes, this regulatory reform bill would effectively overturn the 2015 decision in Madden v. Midland Funding, LLC, which ruled that debt buyers cannot use their relationship with a national bank to preempt state usury limits. Relatedly, the Senate Banking Committee is considering a separate measure, S. 1642.
The same day, in a separate bipartisan vote of 271-145, the House approved H.R. 3978, the “TRID Improvement Act of 2017,” which would amend the Real Estate Settlement Procedures Act of 1974 (RESPA) to modify disclosure requirements applicable to mortgage loan transactions. Specifically, the bill states that “disclosed charges for any title insurance premium shall be equal to the amount charged for each individual title insurance policy, subject to any discounts as required by either state regulation or the title company rate filings.”
Finally, last week on February 8, the House voted 280-131 to pass H.R. 1153, the “Mortgage Choice Act of 2017,” to adjust definitions of points and fees in connection with mortgage transactions under the Truth in Lending Act (TILA). Specifically, the bill states that “neither escrow charges for insurance nor affiliated title charges shall be considered ‘points and fees’ for purposes of determining whether a mortgage is a ‘high-cost mortgage.’” On February 12, the bill was received in the Senate and referred to the Committee on Banking, Housing, and Urban Affairs.
On January 30, the House Financial Services Subcommittee on Financial Institutions and Consumer Credit held a hearing entitled “Examining Opportunities and Challenges in the Financial Technology (“Fintech”) Marketplace.” The Subcommittee issued a press release following the hearing and presented the following key takeaways:
- “Modern developments in digital technology are changing the way in which many financial services are offered and delivered”; and
- “Congress and the federal prudential regulators must continue to examine this innovative marketplace to understand the opportunities and challenges it presents, and to ensure that financial services entities are allowed to use fintech to deliver new products and services while also protecting consumers.”
Opening statements were presented by several members of the Subcommittee, including Subcommittee Vice Chair Keith Rothfus, R-PA, who noted that online lending, mobile banking, and other products could bring capital back to areas deserted by traditional banks. Subcommittee Chairman Blaine Luetkemeyer, R-MO, highlighted that loan originations passed through marketplace lenders accounted for nearly $40 billion over the past ten years, with online lenders often able to offer better lending terms. Luetkemeyer also discussed the rise of mobile banking and lending and raised the question presented by some states of whether fintech companies should be required to comply with current laws that apply to similar products. He stressed that understanding fintech’s capabilities “can better create an environment that fosters certainty and responsible innovation while maintaining consumer protections.” A broad range of topics were discussed at the hearing, including the following highlights:
- Madden v. Midland / True Lender. Companies that have chosen to partner with banks have also run into regulatory and legal roadblocks, including the recent decision in Madden v. Midland Funding, which determined that a nonbank entity taking assignment of debts originated by a national bank is not entitled to protection under the National Bank Act from state-law usury claims. (See Buckley Sandler Special Alert here.) In prepared remarks, Andrew Smith, Partner at Covington and Burling, LLP, stated that because of varying outcomes in true lender court challenges, the lack of certainty means that “market participants will no longer be willing to enter into these types of transactions, thereby depriving consumers, banks, and the economy of the many benefits of bank partnerships with fintech providers while also hampering the liquidity necessary to support a robust lending market.” Smith went on to discuss H.R. 4439, the Modernizing Credit Opportunities Act, which was introduced to “reconfirm and reinforce existing federal law with respect to a bank’s identity as the true lender of a loan with the assistance of a third-party service provider.” Smith emphasized that the legislation would “resolve any uncertainty about a bank’s ability to use third-party service providers by confirming the principle that when a bank enters into a loan agreement, it is the bank that has made the loan.”
- Marketplace Lending. During his testimony, witness Nathaniel Hoopes, Executive Director at the Marketplace Lending Association, highlighted the role marketplace lending platforms (MPPs) have had in delivering products to underserved consumers, but emphasized that a lot of work still needs to happen for more of the “broad American ‘middle class’ to fully realize and benefit from the potential of MPPs specifically and fintech more broadly.” He also expressed support for the Special Purpose National Bank charter currently under consideration by the OCC.
- Regulatory Sandboxes. Witness Brian Knight, Director of the Program on Financial Regulation and Senior Research Fellow at the Mercatus Center at George Mason University, suggested in his prepared remarks various methods to improve the current regulatory environment, and opined that lawmakers could allow firms that participate in a regulatory sandbox program and comply with its requirements to avoid liability as long as the firm makes “customers whole if the firm causes harm owing to a violation of the law.” Knight added that states could be allowed to grant special non-depository charters similar to those offered by the OCC. And while witness Professor Adam J. Levitin of the Georgetown University Law Center agreed that sandboxes would allow companies to explore new ideas with the understanding that customers must be protected, he cautioned that the fragmentation of the regulatory system around fintech makes it hard for experimentation, and that risk would need to be regulated.
- Virtual Currencies. Knight discussed his concerns with initial coin offerings (ICOs) and commented that while ICOs “may enable firms to access capital more effectively than traditional methods, there are significant concerns that they are being used by both outright frauds and well-meaning but ignorant firms to obtain capital in contravention of existing laws governing the sales of securities, commodities futures contracts, and products and services.” However, Knight testified that despite the potential for risk, peer-to-peer payments, cryptocurrencies, and other innovations demonstrate potential, and that innovative lenders are replacing banks in communities where it is no longer profitable for those banks to serve.
- Inconsistent Regulations. During his testimony, witness Brian Peters, Executive Director at Financial Innovation Now, advocated for improved coordination among regulators and stressed that the “current structure is needlessly fragmented and inconsistent among federal regulators, and varies widely across state jurisdictions.” Peters also commented on the need to modernize the regulatory structure to keep pace with innovation and meet consumers’ needs.
On November 15, the House Financial Services Committee (Committee) announced the passage of H.R. 3299, “Protecting Consumers Access to Credit Act of 2017,” which would amend the “Revised Statues and the Federal Deposit Insurance Act” to explain that bank loans that were valid as to their maximum rate of interest in accordance with federal law at the time the loan was made shall remain valid with respect to that rate, regardless of whether the bank subsequently sells or assigns the loan to a third party. This would have the effect of preempting contrary state usury laws and effectively overturn the 2015 decision in Madden v. Midland Funding, LLC.
The bill passed Committee 42-17.
On September 25, OCC Acting Comptroller of the Currency Keith Noreika spoke before the 2017 Online Lending Policy Summit in Washington, D.C. to discuss ways the maturing banking industry can respond to changing market conditions through the adoption of new business models and adjustments to long-term strategies. “Some pundits see the growth of the online lending industry as a response to the nation’s banking industry. And some say that if the industry had been sufficiently agile and fully met the need for lending, alternative lenders would not have grown so rapidly,” Noreika stated. “I do not share that view. I see the growth of online lending and marketplace lenders as the natural evolution of banking itself.”
According to Noreika, about $40 billion in consumer and small business loans in the United States have been originated by marketplace lenders during the past decade, and since 2010, online lending has doubled each year. In fact, Noreika noted, “some analysts suggest that the market will reach nearly $300 billion by 2020, and others suggest as much as $1 trillion by 2025.” However, the online industry faces certain challenges and “adapting to new market conditions and effectively managing evolving risks” is pertinent to their success. Noreika highlighted recent innovation efforts by the OCC, such as the agency’s Office of Innovation’s “Office Hours,” which was created to facilitate discussions related to fintech and financial innovation. (See previous InfoBytes coverage here.) Another example is the OCC’s plan to develop “regulatory sandboxes” and bank pilot programs to “foster responsible innovation by OCC-supervised banks” as a means to expand the OCC’s own knowledge in this space. Importantly, Noreika addressed the OCC’s position concerning chartering of fintech companies that seek to expand into banking, along with the possibility of “offering special-purpose national bank charters to nondepository fintech companies engaged in the business of banking”—a concept currently being contested by both the Conference of State Bank Supervisors (CSBS) and the New York Department of Financial Services (NYDFS). According to Noreika, the OCC has not yet decided whether it will exercise its authority to issue special purpose bank charters. (See previous InfoBytes coverage of CSBS’ and NYDFS’ challenges here and here.)
Finally, Noreika offered support for a legislative approach that would clarify the “valid when made” doctrine central to Madden v. Midland Funding, LLC by reducing uncertainty in establishing that “the rate of interest on a loan made by a bank, savings association, or credit union that is valid when the loan is made remains valid after transfer of the loan” and serving to reestablish a legal precedent that had been in place prior to the Madden decision, in which an appellate panel held that a nonbank entity taking assignment of debts originated by a national bank is not entitled to protection under the National Bank Act from state law usury claims. (See previous InfoBytes coverage here.)
On July 27, a bipartisan group of senators introduced draft legislation (S. 1642), which would require bank loans, sold or transferred to another party, to maintain the same interest rate. As previously covered in InfoBytes, similar legislation (H.R. 3299) was introduced in the House earlier in July to reestablish a “legal precedent under federal banking laws that preempts a loan’s interest as valid when made.” Both measures come as a reaction to the 2015 Second Circuit decision in Madden v. Midland Funding, LLC, in which an appellate panel held that a nonbank entity taking assignment of debts originated by a national bank is not entitled to protection under the National Bank Act from state-law usury claims. The draft legislation seeks to amend the Revised Statutes, the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act.
On July 19, Representative Patrick McHenry (R-N.C.), the Vice Chairman of the House Financial Services Committee, and Representative Gregory Meeks (D-N.Y.) introduced legislation designed to make it unlawful to change the rate of interest on certain loans after they have been sold or transferred to another party. As set forth in a July 19 press release issued by Rep. McHenry’s office, the Protecting Consumers’ Access to Credit Act of 2017 (H.R. 3299) would reaffirm the “legal precedent under federal banking laws that preempts a loan’s interest as valid when made.”
Notably, a Second Circuit panel in 2015 in Madden v. Midland Funding, LLC overturned a district court’s holding that the National Bank Act (NBA) preempted state law usury claims against purchasers of debt from national banks. (See Special Alert on Second Circuit decision here.)The appellate court held that state usury laws are not preempted after a national bank has transferred the loan to another party. The Supreme Court denied a petition for certiorari last year. According to Rep. McHenry, “[t]his reading of the National Bank Act was unprecedented and has created uncertainty for fintech companies, financial institutions, and the credit markets.” H.R. 3299, however, will attempt to “restore consistency” to lending laws following the holding and “increase stability in our capital markets which have been upended by the Second Circuit’s unprecedented interpretation of our banking laws.”
On February 27, the U.S. District Court for the Southern District of New York issued a ruling in Madden v. Midland Funding, LLC, holding that New York’s fundamental public policy against usury overrides a Delaware choice-of-law clause in the plaintiff’s credit card agreement. The court allowed the plaintiff to proceed with Fair Debt Collection Practices Act (“FDCPA”) claims (and related state unfair or deceptive acts or practices claims) against the defendants, a debt buyer that had purchased the plaintiff’s charged-off credit card debt and its affiliated debt collector. The court did not allow plaintiff’s claims for violations of New York’s usury law to proceed, as it held that New York’s civil usury statute does not apply to defaulted debts and that the plaintiff cannot directly enforce the criminal usury statute. The court also granted the plaintiff’s motion for class certification.
 No. 11-CV-8149, 2017 WL 758518 (S.D.N.Y. Feb. 27, 2017).
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If you have questions about the ruling or other related issues, visit our Class Actions practice for more information, or contact a Buckley Sandler attorney with whom you have worked in the past.
On February 27, a U.S. District Court in White Plains, N.Y. issued an Order ruling on motions for summary judgment and class certification in a consumer class-action against a debt collection company that purchased defaulted consumer debt from a national bank, and its affiliate, which sought collection of debt charged at a rate in excess of New York state usury limits. Midland Funding v. Madden, [Opinion & Order] No. 11-CV-8149 (CS) (S.D.N.Y. Mar. 1, 2017).
As previously covered by InfoBytes, the district court had originally ruled in Defendants’ favor, holding that the National Banking Act (NBA) preempted state law usury claims against purchasers of debt from national banks. The Second Circuit, however, overturned that ruling in a May 2015 opinion to the extent it relied on the NBA, but remanded the case for a determination whether Delaware choice of law provisions in the credit agreement precluded the Plaintiff’s claims because the rates were not usurious in Delaware.
Now, revising the issue on remand, the District Court held that New York’s criminal usury cap (but not the civil usury) applies to Plaintiff’s defaulted debt, notwithstanding the Delaware choice of law provision. The Court reasoned that New York does not follow the “rule of validation” (calling for courts to assume the parties intended to enter into a valid contract and apply the law of the state whose usury law would sustain it). The Court concluded, therefore, that the Plaintiff could predicate her FDCPA claims on a violation of New York’s criminal usury cap. Based on the foregoing, the Court granted partial summary judgment for the Defendant. The court also granted, but modified, Plaintiff’s request for class certification.
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