Product innovations continue to shape the way financial services and technology companies, regulators, and consumers interact with one another. In this article, partners Melissa Hall and Mercedes Tunstall explore what’s next for their industries and what makes their practices unique.
Melissa Hall is a bank and payments regulatory attorney and represents her clients on a wide range of traditional bank and finance regulatory compliance and enforcement issues. She has developed a niche advising on emerging regulatory issues in connection with financial technology, including payment systems rules, credit cards and stored value cards, money services businesses, virtual currency transmission and custody, marketplace lending, and consumer financial regulatory requirements.
Mercedes Kelley Tunstall, a former Federal Trade Commission (FTC) lawyer, is widely recognized as a legal leader in fintech and consumer financial services regulation and compliance. She works with companies in a variety of industries on advertising law and privacy and cybersecurity issues. She regularly counsels clients regarding federal banking regulators and defends clients against enforcement actions taken by these regulators, particularly the Consumer Financial Protection Bureau (CFPB).
What are the major trends you’re watching?
Melissa: The primary trend is making financial services more accessible through traditional and nontraditional conduits. There has been a push to get nonbanks more involved in financial services nationwide, whether through bank partnerships or through direct licensing with states. Licensing and regulation of commercial lending is facing increased regulation at the state level, with a focus on improving transparency for small-business lending through disclosures. Commercial lending has traditionally been lightly regulated, and there is often the false assumption that federal laws such as the Equal Credit Opportunity Act do not apply to commercial lending. The Paycheck Protection Program was an interesting development in small-business lending and revealed a lot about the difficulty small businesses can have accessing credit.
Mercedes: In June 2020, the U.S. Supreme Court ruled that the current structure of the CFPB is unconstitutional. The decision means that CFPB can continue its mission, but the president of the United States is now free to fire the CFPB director at any time, without cause. In light of this ruling, I expect to see regulatory uncertainty from the CFPB until the next election. For example, the CFPB had been expected to complete a final rule on the Fair Debt Collection Practices Act prior to the election, but has apparently decided not to move forward with it.
As Melissa noted, there continues to be a lot of innovation in the area of small-business lending. The major banks never got back into small-business lending like they were prior to the last recession, so there is a great need for this type of lending in the marketplace. We are also seeing a lot of alternative arrangements when it comes to digital banking, including partnerships between fintech companies and banks to offer new kinds of deposit accounts and bill-pay functionalities. Many of my clients are looking to develop these kinds of products involving assets consumers already have because they are less risky than lending products that extend credit to consumers.
What are one or two developments in this space that you think are going to have the biggest impact in the next three to five years?
Melissa: I’m closely watching developments in the ability of fintech companies to obtain banking charters. The Office of the Comptroller of the Currency’s (OCC) proposed “fintech charter” is subject to ongoing litigation and, until the litigation ends, is likely not going to be a viable route for a bank charter. The FDIC started granting deposit insurance for state-chartered industrial banks for the first time in 2008, but is facing pressure from both large banks and community banks to level the playing field and ensure that parent companies of industrial banks are regulated as bank holding companies and subject to the same activity restrictions and capital requirements.
The fallout from the Madden v. Midland case in the Second Circuit and the various state and federal responses had and will continue to have a significant impact on bank marketplace lending partnerships. The OCC and FDIC recently issued final rules affirming that a loan that is valid when it is created remains valid when it is sold, even if the purchaser of the loan resides in a jurisdiction where the loan would otherwise be invalid—sometimes called the “Madden fix.” The OCC has also released proposed rules defining for the first time the “true lender” in bank partnerships, stating that the bank is the true lender if at origination the bank is either named as the lender in the loan agreement or funds the loan. A number of cases, especially involving payday lenders, either affirmatively or implicitly rejected this true lender standard and instead applied a “predominant economic interest” standard in determining the true lender.
Both of these are, at their core, part of the decadeslong dispute between the states and federal banking agencies over the scope of federal preemption of state laws, especially consumer protection laws, in the context of financial services.
Mercedes: The direction we go really depends on the next election. If we continue with the current administration, it seems likely that the extent of federal involvement in consumer financial services and banking regulation generally will be diminished. If there is an administration change, I expect that the CFPB will be reinvigorated and expand its rulemaking and enforcement activities. This means that all financial services companies will need to review their risk assessments and most likely reduce the tolerance of risk across the board, but specifically in areas of compliance and operational risk.
Whenever we begin to come out of the pandemic, there will be a great need for alternative credit models. Traditional FICO models will no longer work because broad swathes of the population, who previously had great FICO scores, have found themselves unemployed and unable to pay their bills due to widespread shutdowns of various kinds of businesses. While people get laid off, experience death in the family or have severe illnesses in the normal course of events, and experience a reduction in their FICO score when they struggle with bills, the sheer number of individuals impacted by the pandemic in this way means that new ways of assessing credit risk will be ever more relevant. Even prior to the pandemic, the FICO score was already becoming less useful in predicting the credit risk of an individual over time, and now more than ever, it seems like significant changes need to be made in how we determine credit risks over the next three to five years as we recover from the pandemic. If financial services companies move away from the FICO score in large numbers, then that change will mean that regulators will need to be educated on the alternative credit risk models to ensure that they understand how to properly assess the risk a financial institution takes when extending credit.
What makes Loeb a leader in this space?
Melissa: We are uniquely positioned to advise on every legal issue that a client may face, due to the nature of our Advanced Media and Technology department and the number of different disciplines within that department, from intellectual property, advertising and privacy to financial services and payments technology. The fact that Loeb has a wide range of clients that come to us with fintech and financial regulatory questions, not just traditional financial institutions, means we get a better view of the trends in the marketplace and with the regulators. Because a lot of what we are asked to advise on is so innovative and lacks precedent, the ability to see these trends and patterns is critical in helping clients manage their regulatory compliance and risk.
Mercedes: We have a great relationship with consumer-facing companies, which enables us to keep our fingers on the pulse of what these companies offer their consumers and what their true needs are. Larger banks often focus on innovating financial services products without truly understanding consumers’ interests and purchasing behaviors. Our perspective is unique in that we are ahead of these trends, which allows us to assist our clients in identifying good financial services partners as well as innovation priorities.
What makes your practice unique and different?
Melissa: Rather than approach an issue by starting with the regulations and what the business can and can’t do, I ask my clients what they are trying to accomplish and what their end goal is. Based on these answers, we work together to find ways in which they can develop a product that accomplishes those goals and fits within the regulations. In my view, this is critical in advising on fintech and financial regulation overall because it is rare these days to get a question from a client that neatly fits into existing regulations and precedent. Even though my practice has a regulatory focus, it involves a lot of issue spotting and working with clients to find ways in which they can use the regulations to achieve their business goals. Personally, I have a great interest in technology and innovation, which helps me develop creative solutions for my clients.
Mercedes: My previous positions as an FTC lawyer and in-house counsel at Bank of America have given me a unique perspective that is grounded in the concerns of regulators. In addition, I have focused on technology for my entire career. As a result, I have gained knowledge on why certain financial services technologies have developed in the ways that they have. So not only am I familiar with the way regulators think, but I also have a deep understanding of technology-related concerns, including privacy and security issues. This combination of regulatory and technology-based knowledge uniquely positions me to address new financial products and services from a holistic viewpoint. In addition, my clientele is unique in that it includes not only financial technology startups, but also major banks and consumer-facing companies that want to establish customized financial services offerings rooted in technology. For example, some of my clients may not have a true financial services focus, but they have developed technology that can be used in a financial services context. As such, my practice caters to and impacts a wide variety of clients.
Do you think the measures taken in response to COVID-19 will have significant/lasting regulatory impacts or challenges?
Mercedes: COVID-19 has had a dramatic impact on the U.S. and world economies, and the effects of the pandemic will be with us for a very long time. We are still uncertain as to how long the pandemic will continue, which makes it difficult to predict what this means for the regulatory landscape and what financial services companies will have to do to change and adapt as we begin to recover.
Melissa: I echo Mercedes in that it would be hard to speak to any long-lasting regulatory impacts at the moment. In the short term, we are seeing increasing consumer interest in adoption of contactless transactions, which is an area in which the U.S. financial services system has historically been slower than other jurisdictions to move toward. Due to COVID-19, people are working remotely and are increasingly engaging in financial transactions over the phone or computer in ways that they may not have been as open to prior to the pandemic. The pandemic has really forced us to get more comfortable with using technology on an everyday basis when it comes to financial transactions. As the OCC emphasized in its most recent risk perspective, this presents operational and compliance challenges to financial institutions as the volume and variety of technology-reliant transactions increase at a rapid pace. Also, the remote work environment itself presents challenges due to the increased reliance on telephonic and videoconferencing services to conduct day-to-day business. Even larger financial institutions that have focused on performing technology services in-house have had to rely on programs such as Zoom, WebEx and Google Teams to an unprecedented extent.
Technology is redefining the financial services sector and the ways in which organizations interact with their clients and customers. How do you strike a balance between encouraging clients to implement new technologies while at the same time minimizing associated risks?
Melissa: The last thing I want to do is stifle innovation. One of the advantages of being based in Washington, DC, is being close to the regulators and what they are thinking. It’s a small town. Because the laws are so uncertain in many areas of my practice, it is so important to keep abreast of the trends and know what issues the regulators are currently focused on. With that knowledge, I analyze the risks and present a risk assessment to my clients, outlining the low-, medium- and high-risk options. Based on this analysis, my clients can make an informed decision that makes the most sense for their business.
Mercedes: One of the first questions I ask each client is “Why are you so interested in using a new technology?” What I’m looking to identify is whether there actually is a problem that needs to be solved with new technology, or whether they are interested in pursuing a new technology because it’s trendy. While new technologies can be very powerful, they can also be confusing for consumers to understand and therefore carry with them increased risks. Existing solutions, while they may not be as “sexy,” often carry less risk and can be easier to implement and be more effective.
What changes have you seen in the regulatory landscape to keep up with new technologies?
Melissa: Over the past five to 10 years, there has been an increased willingness on the part of state and federal banking regulators to accept industry feedback. Regulators have come to recognize that there are no clean-cut answers on how to regulate technological innovations. Since the laws can’t keep up with the pace of innovation, regulators recognize the importance of putting forth advice and guidance that incorporate an understanding of how a product works. As such, regulators seem to understand that a balance has to be found between innovation and protecting consumers and financial institutions.
Mercedes: Regulators have come to understand that innovation in the financial services industry is here to stay. All of the federal banking regulators have established offices of innovation, which are staffed with regulators who have either been in the industry or have strong technology backgrounds. These types of offices allow regulators to establish enforcement priorities and identify ways in which laws need to change to keep up with new technologies.