Fintech Law TL;DR (Oct 21)
CFPB Funding Case - New Fed Debit Rule
Hi all 👋
First, let me know if you’ll be at Money2020 and want to meet up! Connect with me via email (fintechtldr@gmail.com) or Twitter, or go here if you want to meet with Lithic.
Second, we released a new bank partner primer Fintech Layer Cake episode. Give a listen here. If you prefer reading, Jared from Costanoa Ventures shared his great notes from the episode.
In the spirit of the times, all of this editions’ images were created by prompts I fed Stable Diffusion.
Short-Circuiting the CFPB
I wasn’t sure I’d get another newsletter out this month and then the 5th Circuit did its thing again so, uhh, hello, nice to see you.
On Wednesday, the 5th Circuit Court of Appeals1 ruled that the Consumer Financial Protection Bureau (CFPB) is funded in an unconstitutional way.
First, a quick history primer: The CFPB was specifically made in a way to make it independent from the political tides and whims of DC. One key mechanism for independence – that the head of the CFPB couldn’t be replaced at will by a new president – was found unconstitutional by the Supreme Court in 2020.
A second key mechanism was how the Bureau is funded. Normally, agencies have to go through the appropriations process, which means Congress has to approve their budgets. So, if, hypothetically, there’s a political party that likes to harp on how regulators have too much power, and that party gets control of Congress, it can gut agencies’ funding and kneecap them.
The CFPB, by contrast, was structured to be funded out of the Federal Reserve’s budget, which doesn’t need to go through Congress. So the Bureau has much more control over its funding.
Two trade groups brought suit against the CFPB’s payday lending rule, throwing every argument they could against the wall to see what stuck.
One of those arguments was that the CFPB is unconstitutionally funded. And the 5th Circuit agreed. The Constitution says, in effect, you can only take money from Treasury if Congress passes a law “appropriating” those funds. But, the argument goes, instead of getting funded from Treasury based on a law providing a budget, the CFPB undercuts that all. Instead, it gets money from the Fed that should have been remitted to Treasury and then doled out pursuant to a budget set by Congress.
Side note: it’s worth remembering that the 5th Circuit court of appeals is considered the most conservative appellate court in the country and is known to make rather…unprecedented rulings. So they, uhh, might not represent what the median court thinks. Then again, who knows.
Let’s cover some implications IF this decision holds up (it’s a big if, and not just because it’s capitalized).
First, the CFPB would have to get its funding through the normal appropriations process. From Congress. So Republicans would have a shot at influencing (read: cutting) the CFPB’s funding. It’s hard to do your job when you’re underfunded, just ask the IRS.
Second, the Fed, OCC, FDIC, and other federal regulators also aren’t funded through the appropriations process. But the 5th Circuit says, in effect, no no, those other agencies are different, the CFPB’s setup went further than they do, don’t worry. And, of course, the court couldn’t be bothered to explain why they’re different. ¯\_(ツ)_/¯
Third, some folks are also worrying that the Bureau’s rules could all get undone. The 5th Circuit in this ruling vacated the rule the CFPB issued in 2017 to regulate payday lenders. If the decision holds, will every CFPB rule be unwound?
I don’t think that’s likely. I imagine the realistic outcome is the CFPB appeals to the Supreme Court and (1) the Bureau’s funding is found unconstitutional but (2) that doesn't unwind their existing rules and (3) the Bureau limps along and has to get funding from Congress.
For the legal eagles that want to go into more weeds, Ballard Spahr has a nice summary of the decision.
Changing Interchange
Earlier this month, the Fed finalized a rule clarifying that more than one unaffiliated debit card network needs to be available for card-not-present (think: online) transactions. This was already the case for card-present (think: in person) transactions.
The idea is the rule will create more competition among debit networks, pushing down the interchange fees that merchants pay.
One likely effect is some degree of reduced debit interchange revenue for fintechs and banks. I’m still digesting it, but I’m not convinced it’s the apocalyptic moment that some folks in fintech think. Why?
First, it will only affect a portion of debit transactions (card-not-present), and already applied to a lot of debit transactions (card-present).
Second, big merchants (think: Amazon and Walmart) negotiate lower interchange rates with the networks (see the public Visa/Amazon UK spat last year). The new rule might push big merchants’ interchange costs lower, but that’s more of a continued trend, not a wholesale change.
Third, just because a thing is available doesn’t mean it’ll be used. Acquirers need to have the capabilities to choose routing, and merchants need to have those functions turned on. There’s a koan in here somewhere (“if an issuer makes debit routing available, and acquirers and merchants don’t use it, does the option even matter?”).
Fourth, heavy-weight payment service providers (think: Stripe) should act on it to reduce their interchange fees when they acquire payments. If they do, do you really think they’ll pass all or even some of the savings onto merchants? No; they’ll likely keep their fees the same and pocket the savings. So it’s likely a boon for PSPs.
I expect there will be some impact from the rule. There almost certainly will be some merchants that benefit. But I don’t think it necessarily spells the death of debit interchange-reliant fintechs.
Elsewhere (non-crypto)
Junk fees have been a hot topic. First, the CFPB issued guidance to consumer reporting companies, saying the companies need to remove “junk data” from credit reports (e.g., inconsistent account info, or factually impossible info). Second, the CFPB sued ACTIVE Network for allegedly tricking people into a “discount” club membership after users signed up for unrelated services. Third, the FTC wants to issue rules for junk fees and asked for public comments.
The DOJ announced Evolve Bank and Trust will enter a consent order to settle discrimination claims relating to the pricing of residential mortgage loans.
House Rep. McHenry and other Republican reps sent a letter to the OCC, saying recent statements and actions risk hurting the innovation and greater inclusion that can arise from fintech-bank partnerships.
Business trade groups are suing the CFPB to try to undo changes the Bureau made that give it the power to police discrimination generally.
The CFPB told Protocol it’s monitoring how some credit-builders might be helping consumers game credit scoring in a way that artificially inflates scores.
Senator Warren released a report about how banks aren’t complying with consumer protection laws (Reg E) by refusing to refund consumers for Zelle scams and fraud. The report adds momentum to the CFPB’s expected plans to issue better liability guidance for banks that offer Zelle.
The FTC is looking at whether Visa and Mastercards’ security tokens for online transactions were used in an anticompetitive way, per WSJ.
The CFPB released its annual report on college credit card agreements, warning that some FIs and colleges may be inappropriately steering students to expensive financial products. The Bureau also released a summary of violations it found in recent student lending and loan servicing exams.
A CA state court rejected OppFi’s challenge to a lawsuit from the state’s financial regulator over the lender’s alleged violation of state usury laws. The court said it didn't have enough information yet to determine if the bank was the true lender.
The CFPB sued MoneyLion for allegedly violating the Military Lending Act by charging more than 36% to service members and their dependents, and for allegedly deceptive practices.
The FTC published a blog for businesses offering BNPL services, cautioning providers over the claims they make.
The CFPB asked for public input on ways to spur new mortgage products that facilitate refinancing and loss mitigation tools (like auto-forbearance), with the goal of promoting competition and household financial stability.
Following a May 2022 blog post where the CFPB called their No Action Letter and Sandbox policies ineffective, the Bureau has now formally rescinded those policies.
Elsewhere (crypto)
The SEC filed a complaint over the sale of Hydro tokens, and some interpret the complaint to provide clear guidance that selling a token on a secondary market after an airdrop is strong evidence a token is a security.
Michael Hsu, the head of the OCC, gave a speech saying the agency is “fairly advanced” on clarity for crypto liquidity risks and finder activities. “I suggest [the crypto industry] hold the champagne until they read the fine print of what we release,” Hsu said.
Crypto exchange Bittrex agreed to pay over $29M to settle OFAC and FinCEN charges for violating sanctions by allowing trading from prohibited countries, and for AML program shortcomings (e.g., not filing SARs).
The SEC keeps up with the Kardashians: Kim Kardashian agreed to pay $1.26M to settle SEC charges related to a promotion she did for EthereumMax without disclosing she was paid $250K for the promotions.
NY’s Attorney General filed a complaint against Nexo for failing to register as a broker-dealer in the state by offering crypto lending services in NY. This follow’s the AG’s warning last year that crypto lending platforms must register or face state action.
A US district court judge ordered Tether to produce records of its token’s backing as part of a lawsuit alleging the organization artificially inflated the price of Bitcoin.
CFTC Chairman Rostin Behnam argued that Bitcoin could double in price under CFTC regulation, per CoinDesk. Which, uhh, seems like the kind of thing regulators shouldn’t say?
CA’s Governor vetoed a bill that would have established a regulatory licensing framework for crypto companies that some had said was similar to NY’s BitLicense.
Some (see WSJ) are arguing that Ethereum’s move to proof-of-stake mining suggests the crypto is sufficiently centralized to be a security, while others (like Paradigm and Coinbase’s Chief Legal Officer) argue it’s not.
Sui Generis (Fun Finds)
Hi. I’m Reggie. I’m a fintech product lawyer at Lithic.
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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. Don’t get your legal advice from Substack, duh.
It was a 3-member panel of the 5th Circuit, not the full en banc court.