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  • Arizona’s fintech sandbox program accepts first participant

    Fintech

    On October 11, the Arizona Attorney General announced the state’s first fintech sandbox participant. The mobile payment platform company will test its product—a centralized wallet infrastructure designed to create “cheaper and faster payment transfers”—for two years by processing guest payments at a Tucson resort. Arizona resident-guests will receive a disclosure agreement outlining the company’s participation in the sandbox, an explanation of the test product, a privacy notice, and the ability to opt out of any information sharing with the resort. As previously covered by InfoBytes, the Arizona governor signed legislation in March creating the first state sandbox program for companies to test innovative financial products or services without certain regulatory requirements. 

    The Attorney General also announced the finalization of a Memorandum of Understanding (MOU) with Taiwan’s financial regulator, the Financial Supervisory Commission, to increase the reach of the state’s sandbox program. The MOU will establish an information sharing agreement “that may result in the opportunity for businesses to develop/test eligible [fintech] products in both markets,” the release stated.

    Fintech State Issues State Attorney General Regulatory Sandbox

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  • Financial Stability Board report: Crypto-assets not yet posing material risk to financial stability

    Fintech

    On October 10, the Financial Stability Board (FSB) published a report, which asserts that although “crypto-assets do not pose a material risk to global financial stability at this time,” there may be implications for financial stability in the future as market developments evolve. The newest report, “Crypto-asset markets: Potential channels for future financial stability implications,” follows a July report discussing the FSB’s framework for monitoring and assessing vulnerabilities in the financial system resulting from developments in the crypto-asset markets. (See previous InfoBytes coverage here.) According to the October report, the FSB conducted an assessment which considered the primary risks present in crypto-assets and their markets, such as “low liquidity, the use of leverage, market risks from volatility, and operational risks,” and determined that, “[b]ased on these features, crypto-assets lack the key attributes of sovereign currencies and do not serve as a common means of payment, a stable store of value, or a mainstream unit of account.” However, the October report discussed challenges to assessing and monitoring potential risks and commented on the following implications that may arise from the evolving use of crypto-assets: (i) reputational risks to financial institutions and their regulators; (ii) risks from direct or indirect exposures of financial institutions; (iii) risks resulting from the use of crypto-assets in payments and settlements; and (iv) risks from market capitalization and wealth effects.

    Fintech Financial Stability Board Cryptocurrency

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  • California to appoint “blockchain” working group

    State Issues

    On September 28, the California governor signed AB 2658, which requires the Secretary of the Government Operations Agency to appoint a blockchain working group by July 1, 2019. (The act defines blockchain as “a mathematically secured, chronological, and decentralized ledger or database.”) The working group is charged with evaluating, among other things, (i) the risks and benefits associated with the use of blockchain by state government and California-based businesses; (ii) the legal implications of the use of blockchain; and (iv) best practices for enabling blockchain technology to benefit the state and its businesses and residents. The act, which has a sunset date of January 1, 2022, requires the working group to provide a report to the legislature by July 1, 2020.

    State Issues State Legislation Blockchain Fintech

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  • New California law requires non-bank lenders and other finance companies to provide commercial financing disclosures

    State Issues

    On September 30, the California governor signed SB 1235, which requires non-bank lenders and other finance companies to provide written consumer-style disclosures for certain commercial transactions, including small business loans and merchant cash advances. Most notably, the act requires financing entities subject to the law to disclose in each commercial financing transaction — defined as an “accounts receivable purchase transaction, including factoring, asset-based lending transaction, commercial loan, commercial open-end credit plan, or lease financing transaction intended by the recipient for use primarily for other than personal, family, or household purposes”— the “total cost of the financing expressed as an annualized rate” in a form to be prescribed by the California Department of Business Oversight (DBO).

    Although the act is effective immediately, the act requires the DBO to first develop regulations governing the new disclosure requirements, and lenders are not required to comply with the provisions of the act until the final regulations are adopted and become effective. Once final regulations are in place, recipients of commercial financing offers will have to sign the disclosures, which are to be provided at the time of the offer. The disclosures must include (i) the total amount of funds provided; (ii) the total dollar cost of the financing; (iii) the term or estimated term; (iv) the method, frequency, and amount of payments; (v) a description of prepayment policies; and (vi) the total cost of the financing expressed as an annualized rate. Finance companies subject to the law are required to provide the annualized financing rate until January 1, 2024, at which time that portion of the disclosure requirement sunsets. The act also allows for finance companies who offer factoring or asset-based lending to provide alternative disclosures using an example transaction that could occur under the agreement.

    Importantly, the act does not apply to (i) depository institutions; (ii) lenders regulated under the federal Farm Credit Act; (iii) commercial financing transactions secured by real property; (iv) a commercial financing transaction in which the recipient is a vehicle dealer, vehicle rental company, or affiliated company, and meets other specified requirements; and (v) a lender who makes no more than one applicable transaction in California in a 12-month period or a lender who makes five or fewer applicable transactions that are incidental to the lender’s business in a 12-month period. The act also does not cover (i) true leases, but will apply to bargain-purchase leases; (ii) commercial loans under $5,000, which are considered consumer loans in California regardless of any business-purpose and subject to separate disclosure requirements; and (iii) commercial financing offers greater than $500,000.

    State Issues Small Business Lending Fintech Disclosures APR Commercial Finance

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  • District Court concludes a small virtual currency is a “commodity” under the Commodities Exchange Act

    Courts

    On September 26, the U.S. District Court for the District of Massachusetts denied a virtual currency trading company’s motion to dismiss, concluding that smaller virtual currencies are commodities that may be regulated by the CFTC. In January, the CFTC bought an action alleging the company violated the Commodities Exchange Act (CEA) and CFTC Regulation 180.1(a) by making false or misleading statements and omitting material facts when offering the sale of their company’s virtual currency. For example, the complaint alleges that the company falsely stated that its virtual currency was backed by gold, could be used anywhere Mastercard was accepted, and was being actively traded on several currency exchanges. Moreover, while consumers who purchased the virtual currency could view their accounts, they were unable to trade it or withdraw funds from their accounts with the company. The company moved to dismiss the case, arguing that the conduct did not involve a “commodity,” specifically one that underlies a futures contract, under the CEA. In denying the motion to dismiss, the court determined that Congress intended for the CEA to cover a certain “class” of items and specific items within that class are then “dealt in.” Because the company offered a type of “virtual currency” and it is “undisputed that there is futures trading in virtual currencies (specifically involving Bitcoin),” the court held that the CFTC sufficiently alleged the company’s product is a “commodity” under the CEA. The court also rejected the company’s other arguments, determining Regulation 180.1(a) was meant to combat the fraud alleged by the CFTC, notwithstanding its use of the term “market manipulation,” and the CFTC adequately pleaded the fraudulent claim under the regulation.  

    Courts Virtual Currency CFTC Regulation Fraud Fintech

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  • Colorado regulator exempts certain cryptocurrency exchanges from money transmitter licensing requirements

    State Issues

    On September 20, the Colorado Department of Regulatory Agencies Division of Banking (Division) issued interim guidance exempting certain types of cryptocurrency exchanges from the state’s money transmitter licensing requirements. Under the interim guidance—which outlines the Division’s interpretation of Colorado’s existing Money Transmitters Act (the Act)— the Division determined that the Act regulates the transmission of money, meaning legal tender, and that cryptocurrencies are not legal tender under the Act. As a result, virtual currency exchanges operating in Colorado do not require a license if transmitting only cryptocurrencies without any legal tender issued and backed by a government (fiat currency) involved in the transaction. However, if fiat currency is present in a transaction, then a virtual currency exchange may require a license. Additionally, a virtual currency exchange must obtain a license when it performs all of the following: (i) it engages in the business of selling and buying cryptocurrencies for fiat currency; (ii) it allows a Colorado customer to transfer cryptocurrency to another customer within the exchange; and (iii) it allows the transfer of fiat currency through the medium of cryptocurrency within the exchange. If a virtual currency exchange offers the ability to transfer fiat currency through the medium of cryptocurrency, the Division encourages the exchange to contact the Division to determine whether it must obtain a license.

    State Issues State Regulators Fintech Cryptocurrency Licensing Virtual Currency Money Service / Money Transmitters

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  • New York Attorney General issues Virtual Markets Integrity Report, following cryptocurrency integrity initiative

    Fintech

    On September 18, the New York Attorney General’s office announced the results of its Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or “crypto” currencies. As previously covered in InfoBytes, last April questionnaires were sent to 13 virtual asset trading platforms to solicit information on their operations, policies, internal controls, and safeguards to protect consumer assets. The resulting Virtual Markets Integrity Report finds that virtual asset trading platforms vary significantly in the comprehensiveness of their response to the risks facing the virtual markets, and presents three broad areas of concern: (i) the potential for conflicts of interest due to platforms engaging in various overlapping business lines that are not restricted or monitored in the same way as traditional trading environments; (ii) a lack of protection from abusive trading platforms and practices; and (iii) limited protections for customer funds, such as the insufficient availability of insurance for virtual asset losses and platforms that do not conduct any type of independent auditing of virtual assets. According to the report, the Attorney General’s office also referred three platforms to the New York Department of Financial Services for potential violations of the state’s virtual currency regulations.

    Fintech State Issues State Attorney General Virtual Currency Cryptocurrency NYDFS

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  • NYDFS files lawsuit over OCC’s fintech charter decision

    Fintech

    On September 14, New York Department of Financial Services (NYDFS) Superintendent, Maria T. Vullo, filed a lawsuit against the OCC arguing that the agency’s decision to allow fintech companies to apply for a Special Purpose National Bank Charter (SPNB) is a “lawless” and “ill-conceived” move that will destabilize financial markets more effectively regulated by the state. As previously covered in InfoBytes, last December the U.S. District Court for the Southern District of New York dismissed NYDFS’ previous challenge because the court lacked subject matter jurisdiction over NYDFS’ claims since the OCC had yet to finalize its plans to actually issue SPNBs. However, in light of the OCC’s July announcement welcoming nondepository fintech companies engaged in one or more core banking functions to apply for a SPNB (previously covered by Buckley Sandler Special Alert here), Superintendent Vullo once again issued a challenge to the OCC’s decision, arguing that it is unlawful and grants federal preemptive powers over state law. Among other things, NYDFS requests the court to (i) declare that the OCC’s decision to grant SPNBs exceeds its statutory authority under the National Bank Act, and specifically that the decision improperly defines the “‘business of banking’ to include non-depository institutions,” and (ii) enjoin the OCC “from taking further actions to implement its provisions.”

    Fintech Courts NYDFS OCC State Issues Fintech Charter

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  • District court rules U.S. securities law may cover initial coin offering in criminal case

    Securities

    On September 11, the U.S. District Court for the Eastern District of New York issued a ruling that the U.S. government can proceed with a case for purposes of federal criminal law against a New York-based businessman who allegedly made “materially false and fraudulent representations and omissions” connected to virtual currencies/digital tokens backed by investments in real estate and diamonds sold through associated initial coin offerings (ICOs). The defendant—who was charged with conspiracy and two counts of securities fraud for his role in allegedly defrauding investors in two ICOs—claimed that the ICOs at issue were not securities but rather currencies, and that U.S. securities law was unconstitutionally vague as applied to ICOs. However, the U.S. government asserted that the investments made in the tokens were “investment contracts” and thereby “securities” as defined by the Securities Exchange Act. The U.S. government further argued that the jury should apply the central test used by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine if a financial instrument “constitutes an ‘investment contract’ under the federal securities laws.” The judge commented that “simply labeling an investment opportunity as ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract—a security—into a currency.” Moreover, while the judge cautioned that it was too early to determine whether the virtual currencies sold in the ICOs were covered by U.S. securities law, he concluded that a “reasonable jury” may find that the allegations in the indictment support such a finding.

    Securities Courts Initial Coin Offerings Virtual Currency Fraud Securities Exchange Act Fintech

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  • Congressman releases report on small business fintech lending

    Fintech

    On August 17, Congressman Emanuel Cleaver, II (D-MO) released a report detailing his findings from an investigation into the small business lending practices of fintech companies, concluding that the algorithms used in the application process may not reduce the risk of discrimination. The report notes that one company disclosed utilized a third-party fair lending consulting firm to assist in preventing discrimination, but that some survey responses “lacked key information or were willfully vague” about how the algorithms help avoid income-based and racial bias. The report cites to other criticisms of small business lending in the fintech industry, including (i) the use of forced arbitration clauses; and (ii) utilizing personal credit scores to establish a business’ credit worthiness. In contrast, the report emphasizes that fintech lending “can be potentially advantageous for small businesses looking to get a leg up in a competitive market” and that fintech companies often serve markets traditionally ignored by banks. The report concludes with a list of best practices and principles for fintech companies that will lend to small businesses, such as (i) registering with the CFPB’s complaint database; (ii) replicating TILA disclosures required for consumers; and (iii) securing third party fair-lending audits.

    Fintech U.S. House Fair Lending Small Business

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