State Bank Regulators Challenge OCC’s Authority to Issue Fintech Charters

On April 26, 2017, the Conference of State Bank Supervisors (“CSBS”) sued the Office of the Comptroller of the Currency (“OCC”) in federal court in Conference of State Bank Supervisors v. OCC, alleging that the OCC’s plan to charter fintech companies as special purpose national banks is unlawful because the process the OCC used to develop the plan was procedurally defective and because issuing such charters would exceed the OCC’s authority.

On May 12, the New York State Department of Financial Services (“DFS”), which is one of the state bank regulators that make up the CSBS, separately sued the OCC in federal court in Vullo v. OCC, alleging, similarly, that the OCC exceeded its authority in planning to issue the charters, and emphasizing that the planned federal charter could threaten New York consumers.

This post discusses the background behind these actions and the issues relevant to the financial services industry in the context of mounting litigation against federal government agencies challenging their authority to enforce financial services laws.

Background—The OCC Fintech Charter

In December 2016, the OCC announced that it would accept applications from fintech firms for charters as special purpose national banks (“SPNBs”).

The term “fintech” is not defined precisely in the Fintech Charter Paper, but it is described as “technology- driven nonbank companies offering a new approach to products and services.” According to the Fintech Charter Paper, these products and services are those that use technology to be “accessible, easier to use, and much more tailored to individual consumer needs” than traditional banking products and services.

The Fintech Charter Paper suggests that the OCC could consider applications from fintech companies that perform any of four services: fiduciary activities, receiving deposits, paying checks, or lending money. Each of these activities is construed broadly by the OCC; for instance, the Fintech Charter Paper analogizes issuing debit cards or facilitating electronic payments to paying checks.

In the Fintech Charter Paper, the OCC invited comments from interested parties. In March 2017, after receiving comments, the OCC released two documents further explaining its process for granting special purpose nonbank charters to fintech companies (and solicited comments on each).

According to the Explanatory Statement, the OCC received more than 100 comments on the Fintech Charter Paper. Having considered the comments, the OCC set out the principles that it will follow to approve any fintech charter: (1) no inappropriate commingling of banking and commerce, (2) no predatory lending or unfair or deceitful practices, and (3) the same standard of supervision for all OCC- chartered entities (i.e., no “light touch” for fintech companies). The Explanatory Statement noted 11 specific areas of concern of the commenters; notably, these included concerns about consumer protection and the OCC’s own chartering authority. With respect to its chartering authority for these purposes, the OCC relies on its statute and chartering authority under 12 U.S.C. 1 et seq. and its rules thereunder, which provide, in relevant part:

The OCC charters a national bank under the authority of the National Bank Act of 1864, as amended, 12 U.S.C. 1 et seq [(the “NBA”)]. The bank may be a special purpose bank that limits its activities to fiduciary activities or to any other activities within the business of banking. A special purpose bank that conducts activities other than fiduciary activities must conduct at least one of the following three core banking functions: Receiving deposits; paying checks; or lending money.

The OCC thus interprets the “business of banking”—a phrase used by Congress in the NBA—to include certain entities that do not engage in the taking of deposits; that is, the Special Purpose Charter Regulation contemplates deposit taking as a sufficient but not necessary component of the business of banking. Companies engaged in fiduciary activities, paying checks, or lending money would also qualif y as being in the “business of banking” under this interpretation.

The OCC’s Charter Evaluation Supplement issued on March 17, 2017, lays out the steps of the chartering process it anticipates for fintech companies, and it also restates the OCC’s position that “a special purpose national bank that conducts activities other than fiduciary activities must conduct at least one of…taking deposits, paying checks, or lending money.” Given the nature of fintech companies likely to apply for charters as special purpose national banks—in the OCC’s view, they are unlikely to be full-service deposit-taking banks—“the OCC anticipates that [special purpose national banks] likely will elect to demonstrate that they are engaged in paying checks or lending money.” It states that the OCC has allowed for new activities as banking changes over time, including electronic provision of any “activity, function, product, or service that [the national bank] is otherwise authorized to perform.”

The CSBS Suit

The CSBS, whose members have an interest in regulating fintech companies, filed a lawsuit in the U.S. District Court for the District of Columbia, seeking to stop the OCC from granting SPNB charters.

The complaint of the CSBS makes a number of extra-legal arguments, including policy-based arguments that state regulators are more effective at protecting the consumers of financial services within their purview than is the OCC as a national regulator.

The CSBS also makes several legal allegations attacking the proposed charters, namely, that:

• The OCC exceeded its statutory authority to issue such charters by relying on the Special Purpose Charter Regulation, because the Special Purpose Charter Regulation was promulgated in excess of the OCC’s authority;
• Even if the OCC has the power to issue the Special Purpose Charter Regulation, the decision- making process used to consider issuing special purpose charters was procedurally defective; and
• The OCC’s decision to issue the charters will unconstitutionally preempt state law regulating fintech entities.

Statutory Authority

The CSBS argues the OCC does not actually have the power to grant fintech charters that the Special Purpose Charter Regulation asserts. Rather, the CSBS alleges that the OCC exceeded its statutory authority in defining the “business of banking” because, the CSBS argues, Congress’s definition of “business of banking” has deposit-taking as a necessary component.

In evaluating the case, the court will have to interpret the NBA—a statute largely unchanged, in relevant part, since 1864—and potentially will have to consider whether it should defer to the OCC’s interpretation as expressed in the Special Purpose Charter Regulation.

The CSBS points out in its complaint that Congress has directly empowered the OCC to charter three types of special purpose national banks—trust banks, bankers’ banks, and credit card banks, and argues that Congress providing explicit authority to issue charters for those three purposes suggests the OCC lacks the authority to charter a special purpose national bank for any other purpose. The complaint also cites definitions of “bank” and “banking” in cases and statutes under which deposit-taking is a necessary function for an entity to be considered a bank.

Administrative Procedure Act

The complaint of the CSBS also alleges that the process the OCC employed to reach its decision to accept applications for fintech charters violated the Administrative Procedure Act. Specifically, the complaint alleges, first, that the Fintech Charter Paper constitutes a rulemaking within the meaning of the term for purposes of the APA, and that it was made without the notice and comment procedures required under the APA. It is important to note that the OCC did not present the Fintech Charter Paper in the form of a rulemaking and almost certainly would disagree with categorizing it as a rulemaking. Second, the CSBS alleges that the OCC engaged in arbitrary and capricious rulemaking in its decision to accept applications for nonbank fintech charters by failing to consider the effects of the decision on the states or concerns raised by commenters, and by failing to conduct a cost-benefit analysis. Arbitrary or capricious rulemaking is impermissible under the APA.

Preemption

The CSBS argues that providing a national bank charter to fintech companies would preempt state law by allowing such entities as nationally chartered special purpose banks to disregard state laws that would otherwise be applicable, and that Congress did not intend to allow the OCC to preempt state law through providing fintech charters.

The DFS Suit

The DFS suit is effectively a “sister suit” to the CSBS suit—the CSBS said that it “strongly supports the lawsuit filed” by the DFS.

The DFS makes many of the same arguments as the CSBS, including arguing that the OCC exceeded its statutory authority in promulgating the Special Purpose Charter Regulation. In particular, the DFS argues (as did the CSBS) (1) that the Special Purpose Charter Regulation is contrary to the meaning of “business of banking” in the NBA—rather than an interpretation of that phrase—and (2) that the fact that the fintech charter would preempt state law means that a court should construe the OCC’s power to issue the charter with a skeptical eye.

The DFS places more emphasis than the CSBS on specific threats to consumers, and, interestingly, to the possibility of a “destabilizing of financial markets” that, it argues, could result from non-New York OCC-chartered payday lenders and other “predatory” lenders exploiting vulnerable consumers in New York without the state being able to protect them with its usury law, which prohibits certain “high-interest, small-dollar” lending.

The DFS emphasizes such harm to New York consumers, as well as the potential harm to itself, if it “loses” New York licensed financial institutions (and the assessment fees they pay to DFS) to the OCC, if such New York institutions acquire a fintech charter.

The OCC’s Response to Date

The Comptroller of the Currency, Thomas J. Curry, referred obliquely to the CSBS suit in a speech on Friday, April 28. In the speech Comptroller Curry made two arguments in defense of the OCC’s announced process for granting charters to fintech companies. First, he detailed the steps taken by the OCC in issuing (i) the guiding principles for responsible innovation, (ii) the Fintech Charter Paper, and (iii) the Charter Evaluation Supplement, and noted that the OCC sought and considered public comments on each. Second, Comptroller Curry described the “business of banking”—using the precise phrase from the NBA—as “dynamic”, and cautioned against “defin[ing] banking as a static state.” In doing so, Comptroller Curry framed a broad interpretation of the phrase “business of banking” from the NBA as the interpretation most consistent with a banking industry that embraces new financial technologies. Of course, the OCC’s interpretation of the phrase in the Special Purpose Charter Regulation is broader than that of the CSBS.

It remains to be seen whether the DC District Court will agree. A victory for the CSBS would suggest state-by-state regulation of fintech firms is in the offing. Such an outcome could be a double-edged sword for fintech firms; on the one hand, regulators in states with a significant fintech presence may have an incentive to foster fintech innovation; on the other, operating a fintech firm across states might become more difficult. Such a defeat for the OCC would also represent a significant limitation on its powers and could fit into a more general trend of courts cabining the authority of financial services regulators, or at least of litigants seeking to have them do so.

With the recent appointment of a new Acting Comptroller, Keith Noreika, by the Trump Administration, early signals are that the OCC will continue to offer the SPNB charter, while also studying ways to lessen the overall regulatory burdens presented by the OCC’s original proposal, particularly the “financial inclusion” requirements.

Other Recent Challenges to Federal Agency Authority over Financial Services Companies

The OCC is not the only agency to face recent legal challenges to its authority to regulate and prosecute financial services firms.

The CFPB: PHH v. CFPB

The Consumer Financial Protection Bureau (“CFPB”) recently sued Ocwen Financial Corporation and certain of its affiliates (collectively, “Ocwen”) for, according to the CFPB, violations arising out of Ocwen’s mortgage servicing business, including illegal foreclosures, sales of loan servicing rights without disclosing or correcting errors in customer data and records, and mishandling of borrower funds.

Ocwen’s answer challenged the CFPB as unconstitutionally structured, echoing similar arguments made by another mortgage servicer, PHH Mortgage (“PHH”).

PHH filed suit against the CFPB after the CFPB’s Director increased a $6 million fine by $103 million in a 2014 appeal of an administrative enforcement action decision. Before a three-judge panel of the D.C. Circuit, PHH won a decision that the CFPB was indeed unconstitutionally structured (though the case will now be reheard en banc). Writing for the panel, Judge Kavanaugh held that an independent agency with a single director who cannot be removed at will by the President is not constitutionally structured — either it must have multiple commissioners or members who may be removable only for cause, or, if it has a single director, that director must be removable at will by the President.

The FSOC: MetLife v. FSOC

The Financial Stability Oversight Council (“FSOC”), established by Congress in the Dodd-Frank Act, has also been under significant litigation pressure. In a high-profile series of actions over the course of 2013 through 2016, the FSOC designated four financial entities as nonbank systemically important financial institutions (“Nonbank SIFIs”), pursuant to its authority under Dodd-Frank to determine that a nonbank financial company’s material financial distress or its activities could pose a threat to U.S. financial stability. Since then, one of the four redirected its financial services business, and FSOC subsequently rescinded its SIFI status.

One of the remaining three, MetLife, however, challenged its designation as a Nonbank SIFI, winning in the D.C. District Court. The Department of Justice has appealed the case on behalf of the FSOC, and the case remains pending.

The Board of Governors of the Federal Reserve System: ABA v. FRB

Congress pulled revenues from a number of sources to fund the transportation expenditures contained in the 2015 highway bill, the so-called FAST Act. One of these revenue sources was derived from reducing dividend payments required to be made by the regional Federal Reserve Banks to each member bank holding stock in the respective regional Federal Reserve Banks. The dividend payment had been set by statute at 6% and contracts between the member banks and the regional Federal Reserve Banks reflected the same rate. Congress, however, reduced the fixed dividend rate of 6% to the lesser of 6% or the return on 10-year U.S. Treasury notes with respect to member banks with at least $10 billion in assets.

When banks began to receive the lower dividends provided for under the FAST Act, the American Bankers Association and Washington Federal Bank sued in the Court of Federal Claims on the grounds that reducing the dividend was a breach of contract or, alternatively, a taking without compensation in violation of the Fifth Amendment. The plaintiffs seek class certification for all 72 U.S. Federal Reserve member banks that received a reduced dividend; i.e., those with at least $10 billion in assets.

The Department of Justice: Quicken Loans, Inc. v. DOJ

The Departments of Justice (“DOJ”) and Housing and Urban Development (“HUD”) investigated Quicken Loans Inc. (“Quicken”), beginning in 2012, for alleged violations of Federal Housing Administration underwriting requirements with respect to loans originated by Quicken beginning in 2007. Shortly before the DOJ filed suit against Quicken, Quicken sued in the Eastern District of Michigan, arguing (among other things) that both the DOJ and HUD had violated the APA, but the court held that Quicken’s complaint failed to identify final agency actions that it could evaluate for compliance with the APA and dismissed Quicken’s suit for failure to state a claim.

Conclusion

It is unclear whether the CSBS and the federal DFS lawsuits may be viewed as part of a recent trend of cases challenging the authority of various agencies in the financial services industry. Other recent cases seem focused on the authority of federal agencies to enforce the federal banking laws, while the CSBS and DFS cases challenge the OCC’s authority to administer its rules governing national bank charters. Further, it remains to be seen whether legal challenges of the authority of federal agencies to administer and enforce financial services laws may result in slowing or stopping agency actions or changing the regulatory “tone” of federal agencies almost eight years after passage of the Dodd-Frank Act.