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New York, California and Illinois Sue OCC to Block “Valid When Made” Rule

Just two months ago, the Office of Comptroller of the Currency (“OCC”) addressed the “valid when made” doctrine and held that interest rates established on bank-originated loans remain valid even after the loan is transferred to a non-bank partner.  On July 29, the attorneys general of New York, California, and Illinois sued the OCC alleging federal overreach that undermines state-preemption regarding usury rate caps.  Specifically, the AGs allege the OCC’s rule is “arbitrary and capricious” in violation of the Administrative Procedures Act.  In the complaint, the AGs allege “[t]he rule is beyond the OCC’s power to issue, is contrary to statute and would facilitate predatory lending through sham ‘rent-a-bank’ partnerships designed to evade state law.”

Those tuned into the debate surrounding the “valid when made” rule saw this court battle coming.  The OCC has recently worked to clarify disputed rules regarding privileges afforded to banks under the National Bank Act.  Under the National Bank Act, national banks that are under the supervision of the OCC are permitted to charge interest on loans at the maximum rate permitted by their home state—even in instances where that interest rate would violate state usury laws.  While federal law carves out this exception for federally regulated banks, it does not extend the same exemption to non-banks.  Accordingly, the attorneys general have asked the Northern District of California to declare the rule invalid and hold that the OCC exceeded the authority granted to it by the National Bank Act and the Dodd-Frank Act. 

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OCC Proposes True Lender Rule

On July 20, 2020, the Office of the Comptroller of the Currency (“OCC”) issued a notice of proposed rulemaking that would determine the “true lender” of a national bank or federal savings association loan in the context of a partnership between a bank and a third party.  The proposed rule states that a bank is a true lender of a loan “if, as of the date of origination, it is named as the lender in the loan agreement or funds the loan” and would apply to all national banks and federal savings associations.  Most recently, the OCC addressed the related “valid when made” doctrine and held that interest rates established on bank-originated loans remain valid even after the loan is transferred to a non-bank partner.  This final rule, however, did not address the true lender question, and this week’s proposed rule does just that.     

The OCC proposed this rule in response to the “increasing uncertainty” surrounding the legal principles that apply to the loans made in the course of bank and third party relationships.  Courts are not unified in their analysis and have looked to both “the form of the transaction” and a battery of fact-intensive tests to determine the true lender of a loan.  While federal rulemaking addresses many relationships between banks and third parties such as making payments and taking deposits, there is not much guidance on these relationships as it relates to lending.  See e.g., 12 CFR 5.20(e).  Per the OCC’s proposed rule, this uncertainty “may discourage banks and third parties from entering into relationships, limit competition, and chill the innovation that results from these partnerships.”  Taken together, these unintended consequences would restrict consumer access to affordable and available credit. 

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SCOTUS Upholds CFPB but not its Singular Director Structure

The Consumer Financial Protection Bureau (“CFPB”) is slightly less than a decade old, created in the wake of the 2008 financial crisis to enforce the nation’s consumer financial protection laws and ensure that consumer debt products are safe and transparent for the consumers who use them.  The Bureau has had only two directors, Richard Cordray and Kathleen Kraninger, with Mick Mulvaney as Acting Director in between.  SCOTUS’s recent ruling will give the president the right to fire the director at will, unless Congress acts to change CFPB to a commission structure (like the FTC).  The ruling is important but leaves a number of unanswered questions likely to spur further litigation and CFPB challenges.

Single Director Provisions and Constitutionality

Unlike many agencies, which are governed by multimember boards and commissions, the CFPB is governed by a single director, who is appointed by the president, confirmed by the Senate for a five-year term, and may only be removed for “inefficiency, neglect of duty, or malfeasance in office.”  See 12 U.S.C. §§ 5491(c)(1),(3). This leadership structure and, by association, the constitutionality of the organization itself, was challenged in Seila Law, LLC v. Consumer Financial Protection Bureau, 591 U.S. ___, (2020) a case on appeal from the Ninth Circuit.  In 2017, the CFPB issued a civil investigative demand (“CID”) to Seia Law LLC, a California law firm specializing in debt-related legal services.  In response to the CID, Seia Law asked the CFPB to set it aside on the grounds that the Bureau’s leadership structure was unconstitutional insofar as its single director structure violated the separations of powers.  The District Court held for the CFPB and the Ninth Circuit affirmed.  See Consumer Financial Protection Bureau v. Seila Law LLC, 923 F.3d 680 (9th Cir. 2019).    

The Roberts Majority Opinion

The Supreme Court of the United States vacated the judgment of the Ninth Circuit and per Chief Justice John Roberts’s majority opinion (joined by Justices Thomas, Alito, Gorsuch, and Kavanaugh), “the CFPB’s leadership by a single individual removable only for inefficiency, neglect, or malfeasance violates the separation of powers.”  See Seila Law, 591 U.S. at 11-30.  Article II provides the president with executive powers that empower him to “take care that the laws be faithfully executed.”  See U.S. Const. art. II.  Time and again, precedent has confirmed that such executive powers permit the president to both appoint and remove executive officials.  In advancing the argument of the Ninth Circuit, Paul Clement, whom the Supreme Court appointed to defend the Ninth Circuit’s ruling, looked to Humphrey’s Executor v. United States, 295 U.S. 602 (1935), where the Supreme Court held that the structure of the Federal Trade Commission (“FTC”) – consisting of five members who could be removed only for cause – did not violate Article II of the Constitution.  Since the 1935 decision in Humphrey’s, the Court has recognized two exceptions to the president’s power to remove those whom he appoints: 

“Congress could create for-cause removal protections for a multimember body of experts, balanced along partisan lines, that performed legislative and judicial functions and was not to exercise any executive power; [and] [sic.] exceptions for inferior officers, who have limited duties and lack policymaking or administrative authority, such as an independent counsel.”  See Amy Howe, Opinion analysisCourt strikes down restrictions on removal of CFPB direction buy leaves bureau in place, SCOTUSblog (Jun. 29, 2020).

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OCC Continues Digital Banking Modernization

The Office of the Comptroller of the Currency’s (“OCC”) attention to modernizing regulation to better accommodate innovative products and industries is continuing full steam ahead since our recent post about a potential payments charter. In the weeks since we posted that article, Brian Brooks has become the acting Comptroller of the Currency, so it should come as no surprise that his goals are garnering some attention.

On Thursday, June 6, the OCC issued a notice of proposed rulemaking seeking public comment to update its rules for national bank and federal savings association activities and operations and an advance notice of proposed rulemaking seeking comment on rules on national banks’ and federal savings associations’ (banks) digital activities. These releases confirm that the agency is “reviewing its regulations on bank digital activities to ensure that its regulations continue to evolve with developments in the industry.”

As part of a substantial modification of the regulatory system, the OCC seeks comment on additional flexibility for banks with respect to permissible derivatives activities, tax equity finance transactions, corporate governance, anti-takeover provisions, capital stock issuances and repurchases, and participation in financial literacy programs.

In addition, the OCC seeks comment on a significant number of banking issues related to digital technology and innovation. The OCC asks whether current legal standards are sufficient flexible, whether they create undue hurdles, and whether there are other areas they should cover. Their requests for comments also touch on current questions, namely whether the pandemic has brought any concerns to light and what issues are unique to smaller institutions – which performed well with the rollout of the SBA’s Paycheck Protection Program, but may encounter hard times to come.

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CFPB Rolls Out Pilot Program Offering Advisory Opinions

The devil is in the details.  The best intentioned new financial services rules and regulations can present challenges for compliance folks trying to implement the rules into their institutions’ existing systems and practices.  Requirements, which may seem simple in the abstract, sometimes create herculean challenges because of system limitations, programming challenges, or simple ambiguity when loaded into real world operations.  To hopefully overcome these compliance obstacles, on Thursday, June 18, 2020, the Consumer Financial Protection Bureau (“CFPB”) began its trial phase of a pilot program offering advisory opinions aimed at “reduc[ing] ambiguity and increas[ing] regulatory certainty, support[ing] proactive consumer protection, and enhanc[ing] the timeliness of guidance.”  The CFPB first previewed this pilot program in March 2020 so that financial services providers could solicit provisional legal opinions on matters pertaining to the interpretation of the Bureau’s rules and laws.

Joining other agencies, like HUD who have had a no action letter procedure in place for years, the CFPB pilot will focus on four stated priorities:  (1) “Consumers are provided with timely and understandable information to make responsible decisions”; (2) “Identify outdated, unnecessary or unduly burdensome regulations in order to reduce regulatory burdens”; (3) “Consistency in enforcement of Federal consumer financial law in order to promote fair competition”; and (4) “Ensuring markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation.”

As the pilot program is new and untested, the CFPB will pick which company questions to answer based on a review of the various petitions, granting priority to those questions that are novel and whose answers might benefit those in the greater consumer financial services community.  The Bureau has said it will consider questions such as those arising during CFPB exams and those that have not otherwise been authoritatively addressed.  In this regard, the CFPB noted the following factors that will drive its prioritization of requests:

  • The request’s alignment with the CFPB’s statutory objectives;
  • The scope of the impact on consumers if the CFPB is to provide an answer or interpretation;
  • In the event where two regulators share concurrent jurisdiction over a specific consumer protection measure, whether the CFPB’s advisory opinion will impact the manner in which the other regulator regulates the same measure; and
  • The impact the advisory opinion would have on the CFPB’s existing resources and personnel.
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OCC Releases Final Rule on Permissible Interest Rates, Addressing Madden Debate

On June 1, 2020, the Office of the Comptroller of the Currency (“OCC”) released a final rule on permissible interest on loans that are sold, assigned, or transferred, and effectively reversed the Second Circuit’s 2015 decision in Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).[1]  In our post on the OCC’s advanced notice of proposed rulemaking (“ANPR”) from November 2019, we discussed how this holding contradicted the “valid when made” doctrine, whereby an obligation is considered valid under the law that applied at the time of origination.  Effectively, a loan’s interest rate was no longer valid when resold to an entity in a state with a lower interest rate cap than where the loan was originally issued.  This week’s final published rule is the first step in addressing the tension between the Second Circuit and the federal powers granted to national banks and federal thrifts.      

An example of the Madden glitch...
An example of a Madden glitch, and visual representation as to why a fix was needed.

Adopted in the form in which it was initially proposed, the OCC’s final rule provides that “[i]nterest on a loan that is permissible under sections 85 and 1463(g)(1), [national banks and federal thrifts] respectively, shall not be affected by the sale, assignment, or other transfer of the loan.”  Published in yesterday’s Federal Register and effective sixty days from now, the final rule reverses the Madden rule and reaffirms the “valid when made” doctrine.  Whereas the Madden decision held that subjecting credit assignees to state usury laws did not significantly interfere with the execution of a national bank’s powers, the OCC disagreed and viewed the decision as an affront to the inherent powers afforded to national banks.[2]  Credit lenders and others in the industry view the OCC final rule as an important and welcomed step in easing the uncertainty created by the Madden rule, citing the rule’s limiting of access to credit markets and propensity for instigating litigation. 

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The Paycheck Protection Program: Managing Fair Lending Risks

The past few weeks have seen increasing scrutiny of the lenders and borrowers participating in the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”), including by the Treasury Department, SBA Inspector General, U.S. Department of Justice, and Congress with the Special Inspector General for Pandemic Recovery surely soon to follow.

Against this backdrop, the Consumer Financial Protection Bureau (“CFPB”) has recently raised concerns related to fair lending for lenders participating in the PPP. On May 6, 2020, the CFPB issued guidance related to the timing for Equal Credit Opportunity Act (“ECOA”)-mandated adverse action notices under the PPP. On April 27, 2020, the CFPB published a statement in which the Bureau emphasized that lenders must comply with ECOA when extending small business credit, outlining key bases for discrimination claims under ECOA and encouraging women and minority-owned businesses who feel they have suffered lending discrimination to submit complaints to the CFPB through its complaint portal.

The CFPB’s recent focus on institutional fair lending compliance accords with that of federal banking regulators. For example, on April 27, 2020, the Office of the Comptroller of the Currency released “OCC Bulletin 2020-45,” which, among other things, encourages institutions to “prudently document their implementation and lending decisions” under the SBA’s PPP.

Given recent regulatory focus on fair lending compliance in connection with PPP lending, banks and other lenders should consider the following proactive risk mitigation steps.

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Regulators Propose CRA Overhaul

Regulators Propose CRA Overhaul

December 17, 2019

Authored by: Benjamin Saul and Ross Handler

On Thursday, December 12, 2019, the OCC and the FDIC issued a notice of proposed rulemaking (NPR) in an effort to modernize the regulatory framework behind the Community Reinvestment Act (CRA). Last autumn, renewed deliberations began when the OCC published an advanced notice of proposed rulemaking (ANPR) that solicited answers to 31 questions about the CRA. In response, national and state-chartered banks, trade associations, community advocates, government representatives, and others submitted nearly 1,500 individual comments. Thursday’s NPR is the culmination of the regulators’ review of these comments and proposed recommendations.

The proposed rule has received support from the OCC and the FDIC. However, the Federal Reserve has been unwilling to sign on to draft plan, leading some to speculate about prospective, competing CRA regimes. Disharmony among the regulators as to how they examine institutions under the CRA would be unprecedented, as the three prudential regulators have implemented the CRA and examined financial institutions in substantially similar manners since the law’s promulgation in the 1970s.

The proposed changes in the NPR to the CRA’s regulatory framework are significant. Key components of the revamped CRA and the NPR include:

  • Additional Assessment Areas Based on Deposit Locations: Currently, whether a bank’s activities qualify for consideration under the CRA depends on the characteristics of the activities and where those activities take place. Under the current framework, the CRA requires that banks delineate assessments areas where the bank has its main office, branches, and deposit-taking facilities, in addition to the surrounding areas where the bank originated or purchased a substantial portion of the loans in its portfolio. Under the NPR, the definition of geographic area is expanded to include areas where banks receive five percent or more of their deposits, if the banks themselves source 50 percent or more of their retail domestic deposits from outside their facility-based assessment areas. Further, the NPR permits banks to receive CRA consideration for qualifying activities outside of the assessments areas, including tribal lands and rural areas.
  • Home Mortgage Lending Restrictions: Under the current CRA framework, home mortgage loans made to high- and middle-income individuals living in low-to-moderate income (LMI) areas receive credit under CRA examination. Moving forward, such home mortgage loans would not receive CRA consideration. Mortgage-backed securities, a controversial yet CRA-eligible activity under the current CRA framework, would not receive the same credit under the NPR. Such securities would only be deemed CRA creditworthy if backed by loans to LMI borrowers and businesses.
  • A Non-exhaustive List of CRA Pre-Approved Activities: As it stands, the CRA does not provide much insight as to prequalified CRA-approved activities. The NPR proposes to create more descriptive and expansive criteria for the type of activities that qualify for CRA credit. To this end, the regulators would provide a publicly available, non-exhaustive list of activities that automatically qualify for CRA credit. Further, the NPR provides a process through which interested parties may submit additional items for consideration for inclusion on the list.
  • Increased Minimum for Small Business and Farm Loans: Under the current CRA framework, the threshold for small business loan or farm loan consideration is set at $1 million. The NPR raises the loan size to $2 million.
  • Metric-Based Benchmarks: The CRA regulations provide for different methods to evaluate a bank’s CRA performance, relative to factors such as the bank’s asset size and business strategy. Banks both small and large have commented that these different methods provide for inconsistent examination processes and results, prompting them to request more streamlined examination criteria. The new performance standards under the NPR would assess (1) the distribution and level of qualifying retail loan originations to LMI individuals, businesses, and farms within its assessment area; and (2) the total dollar value of the bank’s CRA-qualifying activities relative to its retail domestic deposits.
  • Preferential Treatment for Small Banks: Small banks, those defined as institutions with $500 million or less in assets, are provided some preferential treatment under the NPR. Small banks would have the option to be examined under the existing CRA regulatory framework or under the revised framework of the NPR.
  • New Reporting Requirements: Currently, the CRA requires banks to collect and report on a variety of data and loans. Small banks, however, are generally exempt from such requirements. Under the NPR, banks evaluated under the small bank performance standards would be required to collect, but not to report, data related to their retail domestic deposits. Additionally, banks evaluated under the NPR standards would be required to collect, maintain, and report certain data related to qualifying activities non-qualifying activities, and retail domestic deposits, and assessments areas. Banks would be required to collect and maintain all necessary data in machine-readable form.
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Use of Alternative Data in Underwriting Receives ‘OK’ from Federal Regulators

On Tuesday, December 3, 2019, U.S. federal banking regulators issued an interagency statement supporting the evaluation of alternative data when assessing consumers’ creditworthiness. Recognizing that the use of alternative data may improve the speed and accuracy of credit decisions, the agencies hope to address the difficulty facing consumers who are often unable to obtain credit from traditional credit sources. According to FinRegLab, a nonprofit research organization, an estimated 45 million to 60 million consumers lack the credit history needed to generate satisfactory credit scores. Further, millions more do not have access to affordable credit due to low scores and low incomes. The use of alternative data in the rendering of credit decisions may improve credit opportunities, as firms may choose to use these alternatives for those applicants who would otherwise be denied credit.

One such data source is a borrower’s cash flow as an alternative to the traditional credit-evaluation system. Although not an entirely novel concept, and an already well-established part of the underwriting process, some firms are now automating the use of cash flow data to determine a borrower’s ability to repay loans. These newer automation methods have been found to improve the measurement of a borrower’s income and expenses. Most importantly, the automation of a borrower’s cash flow better illustrates income patterns over time from multiple sources as opposed to evaluating a single income source; the borrower information gleaned from these alternative sources is more robust and comprehensive than the information relied upon by traditional credit-evaluation companies. As the regulators highlight in their interagency statement, “cash flow data are specific to the borrowers and generally derived from reliable sources, such as bank account records, which may help ensure the data’s accuracy.”

To the extent firms are using or contemplating using alternative data, the agencies encourage responsible use of such consumer data. As the sources of alternative data grow, both banks and non-banks will need to determine which types of alternative data might carry more risk to consumers – and do their best to minimize or justify the use of such data sources. Although cash flow data provides a relatively unbiased predictor of loan repayment ability, some lenders have garnered fair lending scrutiny for their use of certain alternative data such as borrower occupation, education and information from social media. As the agencies made clear in their statement, lenders considering the use of alternative data must take steps to ensure consumer protection risks are “understood and addressed.” Accordingly, it will remain vitally important for lenders leveraging alternative data to do so within a well-developed fair and responsible lending program that includes, among other things, periodic fair lending testing.

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OCC and FDIC Clarify the “Valid When Made” Debate

On November 18 and 19 of this week, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued Advanced Notices of Proposed Rulemaking (ANPRs) to clarify how state interest rate caps should apply when loans are sold across state lines.

Example of a Madden Glitch

The proposal from the OCC reaffirms the “valid when made” doctrine, on which many marketplace lenders have relied and which was central to the Second Circuit’s 2015 decision in Madden v. Midland Funding LLC, 786 F.3d 246 (2nd Cir. 2015). The Second Circuit’s decision contradicted the “valid when made” theory, whereby an obligation is considered valid under the law that applied at the time of origination. The Second Circuit held that a loan’s interest rate was no longer valid when resold to an entity in a state with a lower interest rate cap than where the loan was originally issued. In its proposed rule, the OCC “has concluded that when a bank sells, assigns, or otherwise transfers a loan, interest permissible prior to the transfer continues to be permissible following the transfer.” The OCC’s proposed rule would cut against Madden, allowing the interest rates attached to bank loans to remain valid once transferred to a bank’s fintech partner of investors.

The FDIC’s proposed rule parallels that of the OCC, but focuses on Madden’s relation to state-chartered banks. The FDIC’s proposed rule clarifies that the legal interest rate on a loan originated by a state bank remains legal even after the loan is sold to a non-bank. Speaking in a statement on Tuesday, FDIC Chairwoman Jelena McWilliams said “This proposed rule would correct the anomaly by establishing in regulations … that the permissibility of interest would be determined when a loan is made and is not impacted by subsequent assignment, sale, or transfer.” The draft regulations issued on Tuesday by the FDIC affirm that state banks are not bound by the interest rate caps of other states in which they operate. Further, the validity of the loans’ interest rates would be fixed at the time of origination.

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