FinTech Law TL;DR (July 31)
CA Payday Report -- BlockFi -- Infra Bill
Hey all 👋
Welcome to all the new folks this week (hi, Plaid and Gil!).
Gonna be at Moov’s FinTech Devcon? Let me know and let’s meet up! All the cool kids are going. FinTech Law TL;DR readers get a 15% discount with the code “tldr”.
I’ll also be at the SF FinTech Happy Hour this upcoming Thursday, so come say hi!
The CFPB overdraft study I shared in the last newsletter is actually from 2014 (thanks, Jon!). I was still in vacation mode...interesting data, nonetheless.
Lots of crypto news so I’ve split this week into traditional finance (TradFi) + crypto.
TradFi
CRA Changes Coming
So one of the U.S.’s historic policies is that banks should (1) serve their community and (2) not discriminate by limiting who counts as their community (think: redlining).
This is (theoretically) accomplished through the Community Reinvestment Act (CRA):
Regulators give banks CRA “ratings” and evaluations based on how well they serve their community (e.g., lending in low-to-moderate income areas will win you points).
If banks want to add branches (lol), or be part of a merger or acquisition, regulators can look to CRA evaluations to decide whether to approve or reject the proposal.
In practice, the CRA has a few problems:
Current review standards are opaque and subjective.
Most banks get good ratings even if they underallocate to underserved communities.
The CRA was passed in the late 70s and designed for banks with those Stone Age features called branches. Not digital-first or digital-only banks or bank partners.
Well, this past week the OCC, Fed, and FDIC released an interagency statement1 saying…nothing, really:
“[We] are committed to working together to jointly strengthen and modernize regulations implementing the [CRA].”
On its face, it doesn’t say much. But it signals there’s a triumvirate of top regulators prioritizing CRA updates, so you can expect some interesting proposals coming soon.
Regulators are going to have to wrestle with some fascinating questions here, like:
What does it mean for a digital-first or digital-only bank to serve its community? What even is its community?
Should bank partners carry some CRA burdens? Right now, they really don’t, and CRA burdens could raise regulatory costs and barriers to entry for FinTechs.
CA Payday Report
CA’s financial regulator released a report on CA payday lenders. Some highlights:
The number of payday loans declined 40% from 2019 to 2020.
49% of payday customers had average annual incomes of $30K or less.
The number of payday borrowers referred by lead generators declined 69% from 2019 to 2020 (315.0K to 98.5K, respectively).
Payday lending locations decreased 27.7% from 2019 to 2020.
No doubt COVID drove a lot of the changes, so I’ll be curious to see what the reboudn is in 2021. Also unclear: how much this data can be generalizes to the rest of the US.
Coming Soon: 1071
So Dodd-Frank was passed to help fix some of the broken bits in the US financial system after 2008.
Buried in it is Section 1071, which is intended to help enforce fair lending and community needs for business loans.
Specifically, 1071 requires lenders to report demographic info on the loan apps they receive. This is already standard fare for mortgage apps.
Well, Dodd-Frank was passed over a decade ago and the CFPB has done almost nothing for issuing the regs Section 1071 needs.2 🤦♂️
States sued over this delay and the CFPB just entered a court agreement saying “OK, we’ll publish a notice with kick-off questions by September 30.”
Section 1071 is going to require a good amount of resources from banks and lenders to implement, so we’ll circle back on this as the regs roll out.
Elsewhere in TradFi...
📈 TikTok banned paid promos of financial services and products.
👀 Hide your laser eyes: SEC Chair Gary Gensler is now on Twitter.
🌊 The OCC announced its first Climate Change Risk Officer.
👀 Sherrod Brown asked the CFPB how it plans to handle Chime’s account closures and other FinTech banks.
📈 Robinhood IPO’ed.
👮 PayPal’s most recent SEC filing disclosed it’s facing SEC probes over potentially non-compliant interchange rates and marketing fees from its branded card program. Peter and Matt think it’s because PayPal didn’t disclose the risk of losing revenue as a result of Durbin exemption gaps being closed.
📓 The CFPB issued a brief detailing that credit applications have returned to pre-pandemic levels overall, though subprime and deep subprime apps have not (see also, “K-recovery”).
🎂 The CFPB turned 10 years old.
👀 Democratic Senators introduced a bill to impose a federal 36% interest rate limit. Jason’s analysis on it is worth reading.
👏 NY’s financial regulator issued a letter to NY-regulated institutions outlining that they’re expected to make board and senior leadership diversity a business priority and part of corporate governance.
📖 The CFPB retracted its postponement of the Fair Debt Collection Practice Act’s final regs, which will now go into effect Nov. 1.
Crypto
Oof, lots going on.
BlockFi Orders
Disclosure: I have a BIA account.
BlockFi received cease and desists3 from NJ, AL, TX, and VT over the BlockFi Interest Account (BIA), telling BlockFi to stop offering the BIA to new customers in the relevant states.
What Is a BIA?
Matt Levine has a nice breakdown of the BIA (does he never not?) but the gist is:
You deposit crypto in a BIA.
BlockFi lends the crypto out to others (“institutional and corporate borrowers” on an over-collateralized basis) or uses it for proprietary trading.
BlockFi pays you some of the profit it makes from step 2 in the form of “interest.” These rates currently range from 4% for the first .25 of BTC to 7.5% or more for stablecoins.
BlockFi describes the BIA as an “interest-bearing account.” Conceptually, it sort of feels like a bank account, right?
You deposit funds in your bank’s savings account.
The bank uses your deposit to make $$.4
The bank pays you some of its profit as interest.
But there are some key differences from a traditional bank account:
Your BIA is not insured by the FDIC (crypto is not “legal tender” that can be insured) or SIPC (BlockFi says it’s not a brokerage account).
BlockFi is probably making most of its $$ from lending to traders. Banks, instead, lend capital for mortgages, business loans, and other more tangible things.
What the Orders Say
The cease and desists orders see the BIA as a security (see the TL;DR overview on crypto). They use language like you “purchase a BIA”, not “you deposit in it.” And that (if true) means BlockFi was selling unregistered securities.
BlockFi Plans to Fight
BlockFi is likely taking the view the BIA is more like a bank account, which doesn’t count as a security (see this Preston Byrne thread for the legalese).
Zac Prince, founder and CEO of BlockFi, sent an email to users this week saying, in part:
Treat Your Lawyers Well
These regulatory notices also caused Third Point to back out of a BlockFi funding round.
Reminder: your regulatory strategies and lawyers can have very real business effects beyond fines.
Infra Bill
Congress is pushing a $550B infrastructure bill forward:
Hidden in it is language that expands the definition of “broker” in the tax code to cover pretty much everyone in crypto.
The tax code requires brokers to file Form 1099s with the IRS, which includes customers’ names, address, contact info, etc.
Aka, most everyone in crypto will need to do basic KYC on users and report that info to the IRS.
Shout out to Jake Chervinsky for flagging this; his take is worth reading:
Circle Disclosures
Circle made a few spicy disclosures in a recent regulatory filing ahead of its IPO. Many stem from Poloniex, the crypto exchange Circle acquired in 2018 (and later divested).
The disclosures were clearly written by securities lawyers since they disclose risks without actually providing enough details to understand why:
It set aside $10.4M to settle SEC charges related to Poloniex’s “trading of [crypto] that may be characterized as securities.”
Circle has received OFAC inquiries over Poloniex allowing accounts from embargoed jurisdictions and processing transactions that may have violated sanctions.
Circle is expecting to get occasional fines from Poloniex’s unlicensed money transmitter activities.
Circle “believes penalties and fines are probably” following 2018 subpoenas from government agencies. They don’t give more detail 🤔.
In June, it had an “internet email fraud incident” where fraudsters stole $2M of company funds.
No 1031 Crypto Exchanges
Section 1031 of the tax code says you won’t trigger taxes if you exchange property “of like-kind” that’s used for trade, business, or investment.
1031 typically comes up for investment property. If you sell an investment property and invest the proceeds in another (within 180 days), you avoid paying taxes on the sale of the first property.
Crypto stans have said for a while that 1031 should apply to crypto.
Well, in response to a taxpayer’s letter, the IRS just said Section 1031 does not apply to pre-2018 exchanges of (1) BTC to ETH, (2) BTC to LTC, or (3) ETH to LTC.
The logic is:
During that time, BTC and ETH were used as “on/off-ramp” tokens to access other altcoins. So exchanging BTC/ETH for LTC isn’t an exchange of similar assets.
BTC is designed for payments, but ETH is designed for payments + smart contracts and dapps. So exchanging the two is also not “like-kind.”
It’s an IRS letter about one specific instance, so it can’t technically be cited or relied upon by other people. But it’s another data point for navigating what, exactly, crypto is.
Uniswap Delists Tokens
Uniswap Labs is a centralized interface for accessing Uniswap, a decentralized trading platform. This week, Uniswap Labs removed a ton of tokens that are (...easily...) arguably securities from its interface, likely to head off the increasing DeFi scrutiny from regulators.
Drew Hinkes has a good hot take on this, and I love his framework of “legally addressable actors.”
Practically, crypto regulation is an issue of whether there are legally addressable entities you can regulate. Uniswap Labs is. Uniswap itself is not.
Elsewhere (in crypto)...
🏦 Top financial regulators met to discuss stablecoins. Yellen said there was “need to act quickly” and they seem skeptical that Tether actually has USDT backed by the US dollar.
👮 Tether execs are facing criminal fraud charges.
📈 Binance and FTX decreased leverage limits from over 100 down to 20x in light of increased regulatory scrutiny.
Sui Generis (Fun Finds)
Fire season is kicking off in the US: “Fighting an actual wildfire . . . can cost over $6,000 an acre. But . . . even at the high end, a prescribed burn will cost you only $300 an acre. That’s more than 20 times less.” (Fighting Fire with Fire)
If you have to negotiate a big agreement, consider pre-announcing the news so regulatorynerd can tell you what provisions you should include:
Bumble settled a class action lawsuit in CA based on discrimination against male users (since only women can send the first message on a match). And plaintiffs get TWENTY FREE SUPER SWIPES?!
Credit Suisse released the external investigation report on its Archegos blow up. And, as King Levine beautifully summarizes, it was caused not by a failure of financial savviness, but by human psychology.
About
Hi. I’m Reggie. I’m a lawyer at BlueVine. If you want to connect or are on the FinTech job hunt, come say hi on Twitter or send an email: fintechtldr@gmail.com.
Any views expressed are my own (well, sort of? I mean, they’re based on laws and regulations, so they’re not really “mine”?). Nothing here is legal or financial advice.
Here are the foundational FinTech laws and regs if you want a closer look at anything.
The OCC also rescinded a final CRA rule it issued last May that had begun tackling some of CRA’s problems.
The main thing the CFB has done on 1071 is a SBREFA review. If a law affects small businesses, the CFPB is required to do a report on what SMB effects there may be and seek SMB input. That’s a SBREFA review.
Technically, they’re not all actual orders. At least one is a notice that there is a cease and desist coming soon.
Yes, yes, this is an oversimplification.