United States: OCC & NYDFS Battle To Regulate FinTech

Last Updated: July 20 2017
Article by Jeffrey Alberts and Ingrid He

In a recent article published in Bloomberg BNA, Jeffrey Alberts, Co-Chair of Pryor Cashman's FinTech and Financial Institutions Groups, and Ingrid He explored the ongoing battle between the Office of the Comptroller of Currency (OCC) and the New York Department of Financial Services (DFS) for regulatory control of FinTech companies. Excerpts from the article are published below.

OCC vs. DFS: Battle for the Future of FinTech

In the rapidly developing world of financial technology it often is unclear who has the legal authority to regulate the activities of newly created companies. Right now, a major battle is under way between state and federal regulators who are competing to draft and enforce the rules that will guide the future development of the FinTech industry. This battle recently has spilled out from behind the closed doors of bureaucratic negotiation into open public attacks and lawsuits, creating even greater uncertainty amongst FinTech companies about their future regulatory obligations.

State Regulators Want to Regulate FinTech

To understand what brought these regulators, who usually strive to appear cooperative in the eyes of the public, to openly attack one another, it is necessary to look at how state and federal regulators have responded to developments in the FinTech industry. Over the past several years, state regulators have been staking out positions as leading regulators of FinTech companies.For example, in June 2015, DFS promulgated rules for the licensing of virtual currency companies, which the DFS itself dubbed "BitLicenses." Other state regulators, such as the Washington State Department of Financial Institutions, the Texas Department of Banking and the Connecticut Banking Department have instituted, or been granted authority to promulgate, similar regulations.

OCC Issues FinTech White Paper

During this same period, federal regulators have announced the intention to assert control over the regulation of FinTech companies. The argument for federal regulation was advanced in its most compelling form in December 2016, when the OCC published a white paper announcing that the OCC was considering granting special purpose national bank (SPNB) charters to FinTech companies. The OCC framed its goal in proposing these "FinTech Charters" as keeping up with the innovative technologies in the financial sector and responding to the rise of "technology-driven nonbank companies offering a new approach to products and services."

In response to concerns from traditional banks that certain companies receiving FinTech Charters would not be depository institutions subject to the FDIC's regulations, resulting in these FinTech companies receiving an unfairly lower regulatory burden, the OCC indicated that while it is true that in some cases an "SPNB that does not take deposits will not be subject to certain requirements that apply only to insured depository institutions . . . [t]he OCC has the authority to impose special conditions requiring the applicant to comply with standards that generally apply only to insured banks."

DFS's Public Criticism of the OCC

While industry insiders had predicted the possibility of inconsistency, or even tension, between the OCC and the DFS, most assumed that this would be worked out behind closed doors. From its first response to the OCC's FinTech White Paper, however, the DFS made clear that it was willing to take its gloves off to defend its jurisdiction over FinTech companies.

In the DFS's comment letter on the OCC's proposal, DFS Superintendent Vullo did not limit herself to making policy arguments about how national regulation can interfere with state regulatory experimentation or with the ability of state regulators to respond to unique demands of businesses in their jurisdiction. Rather, Superintendent Vullo directly attacked the OCC itself. For example, she concluded her letter by stating that "the proposed 'fintech' charter substitutes an effort to appear innovative for a complicated, problematic new regulatory regime."

Perhaps most shockingly, Superintendent Vullo suggested that the OCC's ineptitude as a regulator permitted HSBC Bank US to engage in the money laundering transactions that resulted in HSBC being fined $1.9 billion in 2012. She noted that "HSBC Bank US was chartered by NY DFS until June 2004 when it became regulated by the OCC" and further noted that at the time HSBC obtained an OCC charter, "HSBC was under a Written Agreement with the NY DFS . . . due to shortcomings in its BSA/AML program."

The Lawsuit

The DFS did not limit itself to criticizing the proposed FinTech Charters. On May 12, 2017, the DFS filed a lawsuit against the OCC in the District Court for the Southern District of New York, alleging that the OCC's proposed FinTech Charters exceeded the agency's statutory authority under the National Banking Act and violated the Tenth Amendment. Based on these claims, the DFS sought declaratory and injunctive relief that would declare the proposed FinTech Charters to be unlawful and prohibit the OCC from creating or issuing these charters in the absence of express authorization from Congress.

As in the DFS's previous attacks on the OCC's proposal, the filed Complaint did not pull any punches. In the Complaint, the DFS described the OCC's decision to issue FinTech Charters as "lawless, ill-conceived, and destabilizing of financial markets that are properly and most effectively regulated by New York State," further noting that it "puts New York financial consumers – and often the most vulnerable ones – at great risk of exploitation by federally-chartered entities improperly insulated from New York law."

This litigation is pending, and the OCC has not yet filed an Answer to the Complaint.

Where Things Stand for FinTech Companies

While streamlining and clarifying the regulatory framework may have been the OCC's goal, in some ways the regulatory landscape has become more confusing for FinTech companies.

First, as the DFS asserts in the pending lawsuit, it is questionable whether the OCC has statutory authority to issue SPNB charters to nontraditional banks. If the DFS prevails in its lawsuit, then the OCC may never issue SPNB charters to FinTech companies.

Second, regardless of the ultimate outcome of the DFS's lawsuit against the OCC, there will still be no clarity on the proposal while the lawsuit is pending. The current lawsuit may not be resolved before the district court this year, and appellate litigation could further delay the ultimate resolution of this issue.

Third, even if the OCC prevails and begins granting FinTech Charters, state agencies such as the DFS will still attempt to regulate FinTech companies. This could lead to future disputes over the nature and scope of the federal preemption of state regulations, which will add to the confusion over which regulations apply to which FinTech companies.

While these guidelines have relatively well-defined meanings for traditional banks, it is much less clear how regulators will apply requirements such as adequate capitalization and sufficiently detailed profitability milestones to FinTech companies, many of which are relatively small start-ups. As a result of these issues, FinTech companies have little idea what the future regulatory terrain will look like. This uncertainty makes it difficult for companies to predict the future regulatory cost of business decisions they would like to make today. It also concerns investors, who are worried that regulatory burdens could severely impact the profitability of FinTech companies.

For now, those in the FinTech industry are hoping that state and federal regulators will resolve their differences and clarify the regulations that will apply to FinTech companies. Until then, regulatory uncertainty will continue to impede the growth of FinTech companies in the United States.

Read the Full Article

The full Bloomberg BNA article can be viewed here.  

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Jeffrey Alberts
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