Alston & Bird Consumer Finance Blog

California

California DFPI Digital Asset Lending Regulatory Year in Review

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A&B ABstract:

In December of 2022 California released an interagency progress report (“Report”) analyzing the current regulatory status of Web3, Crypto Assets, and Blockchain. The report was prepared pursuant to Executive Order N-9-22 (the “Order”) issued by California Governor Gavin Newsome on May 4, 2022, which declared California’s intent to regulate blockchain, including crypto assets and related financial technologies, and directed California state agencies, including the Governor’s Office of Business and Economic Development (“GO-Biz”), the Government Operations Agency, the Business, Consumer Service and Housing Agency, and the Department of Financial Protection and Innovation (“DFPI”) to collect feedback from various stakeholders to understand the risks and explore opportunities for the state. The Order, among other directives, advises these California agencies, led by DFPI, in consultation with GO-Biz, to create a regulatory framework for crypto assets in coordination with federal and state authorities, with the goals of ensuring equity, regulatory clarity, consumer protection, innovation, and job growth. Although these new technologies present some novel questions, for entities engaging in lending backed by digital assets, the DFPI has made clear that the California Financing Law and similar regulatory burdens apply.

Current Registration Requirements

The Report follows earlier requests for public comment, including from the DFPI, which published a request for public comment (the “Request”) stating an intent to develop a comprehensive state regulatory framework for the offering of digital asset related financial products and services in California. Within the previous request for comment, the DFPI states that it possesses the authority to develop comprehensive regulations under the California Consumer Financial Protection Law (CCFPL), which authorizes the DFPI to “prescribe rules regarding registration requirements applicable to a covered person engaged in the business of offering or providing a consumer financial product or service.” Accordingly, the DFPI has put forth that it currently has the authority to require licensing and regulation of crypto asset-related financial products. In the Order issued by Governor Newsom “crypto assets” is defined as “a digital asset, which may be a medium of exchange, for which generation or ownership records are supported through a blockchain technology.” Given this backdrop, we can expect the DFPI to issue regulations without further legislative input.

Public Feedback

Responses to the request for comment and other opportunities to provide public input resulted in several key suggestions for regulation, including the following:

  • Provide regulatory clarity—including by basing regulations on specific types of activities, products, and services (rather than specific entities).
  • Harmonize with federal guidelines—including by modeling key terms and requirements on those used by federal regulators.
  • Avoid over-regulation—including by minimizing compliance costs.

CCFPL Regulation and Supervision

The Report states that DFPI has issued licenses to 10 crypto asset related companies that engage in lending activities under California financial licensing laws. Some make consumer loans that are secured by crypto assets, while others make commercial loans to crypto asset-related companies. In addition to licensing and other compliance activity, the Report further notes that enforcement actions were also underway. The highlighted enforcement actions within the report related to companies allegedly operating crypto deposit accounts that qualified as unregistered securities as well as investment schemes. The Report did not highlight any enforcement actions related to loans secured by crypto assets or other licensing violations.

However, on November 18, 2022 and November 22, 2022, the DFPI suspended California Financing Law licenses for two entities in connection with their crypto asset platforms. In both instances, the entities paused activity on their platforms. The investigation of one entity remains ongoing while the other entered into an agreement to pause collection of repayments and interest on loans belonging to California residents while its CFL License is suspended or as further agreed to between the DFPI and the entity.

Takeaway

While many aspects of Web3, Crypto Assets, and Blockchain regulation remain unclear, it is clear that those engaging in lending activities collateralized or otherwise related to such assets are regulated under the CCFPL and other California law, and must abide by the same strictures as any other lender.

California Settlement Offers Reminder that Buy Now Pay Later Participants are Subject to California Financing Law

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In August 2022, the California Department of Financial Protection and Innovation (“Department” or “DFPI”) entered into a consent order with a company offering point of sale financing products that the DFPI deemed to be buy now, pay later (“BNPL”) financing, for which a California Financing Law (“CFL”) license is required. The company is required to pay a penalty, refund previously collected fees from California residents, and obtain a CFL license.

The settlement follows an annual report released in October of 2021 in which the DFPI noted a sharp increase in BNPL “consumer loans.” In the accompanying press release to that report, the DFPI stated:

BNPL loans are an increasingly common type of short-term financing that allows consumers to make purchases and pay for them at a future date, often interest-free. Sometimes referred to as point-of-sale installment loans, BNPL products are becoming a popular payment option. The report shows a surge in BNPL unsecured consumer loans reported to the DFPI. This product has grown in recent years and has come under the DFPI regulatory umbrella.

The press release also noted that the Department had rendered prior legal opinions and entered into settlements with three separate BNPL / point-of-sale financers in 2019 and 2020 that were deemed to be structuring their BNPL products in a manner designed to evade regulation under the CFL. These companies had agreed to refund fees to consumers and obtain CFL licenses, and among other requirements, must: (i) consider consumers’ ability to repay loans, (ii) comply with rate and fee caps, and (iii) respond to consumer complaints

In one of those prior opinions, the DFPI (formerly, the Department of Business Oversight) asserted that the CFL applies to making consumer loans and noted that the CFL defines “consumer loan” as a loan “the proceeds of which are intended by the borrower for use primarily for personal, family, or household purposes.” (Note that loans in the principal amount of $5,000 or less for other than personal, family, or household purposes are also included in the definition, bringing certain commercial or business-purpose loans within the scope of the CFL). The Department further stated that the CFL incorporates certain aspects of the common law, including that merchants may sell goods in exchange for cash or in exchange for a consumer’s promise to pay later (a “credit sale”) and that a merchant may charge a premium for credit sales without the transaction being subject to the state’s loan laws and without the premium being subject to the state’s usury limit. The DFPI concluded, however, that “[e]xtensive third-party involvement may cause transactions to be deemed loans even if the underlying credit sale is bona fide.”

Taken together, the Department’s prior statements, opinions, and enforcement actions signal a broad interpretation of the CFL that could potentially apply to many lenders and third parties involved in point-of-sale financing, including the offering of buy now, pay later products. In the press release accompanying the most recent enforcement action, the DFPI concluded that it “continues investigating other companies offering Buy Now, Pay Later products.”

New Proposed Registration Requirements for Covered Financial Products and Services Under the California Consumer Financial Protection Law

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Last year, California passed the California Consumer Financial Protection Law (“CCFPL”), which renamed the Department of Business Oversight as the Department of Financial Protection and Innovation (“DFPI”) and expanded the authority of the department, including increased regulatory authority related to certain financial products. Under that widened purview, the DFPI has now proposed regulations requiring registration for certain financial product providers, including education financing and wage-based advances.

The CCFPL as Enacted

Under the statute, certain regulatory burdens apply to “covered persons” and “service providers” that broadly encompass entities offering extensions of credit and other consumer financial services and products, with certain exceptions and exemptions. With respect to the currently proposed regulations, the CCFPL allows the DFPI, with certain exemptions, to prescribe rules regarding registration requirements applicable to a covered person engaged in the business of offering or providing a consumer financial product or service. The CCFPL also states, however, that registration will not be required for any covered person licensed by the department under another law and who is providing a financial product or service within the scope of that license. The DFPI has sought comments regarding the proposed regulations including specifically “to clarify whether and when the registration requirements apply to Department licensees and licensees and registrants of other state agencies.” Comments on this and other potential issues with the proposed regulations may be submitted by December 20.

The Proposed Regulations

The proposed regulations, if finalized, would require registration for “subject products,” including for covered persons providing wage-based advances or education financing. Waged-based advances are defined in the proposed regulations as “funds paid to workers by a provider other than an obligor that are based on wages or compensation that a worker or the worker’s obligor has represented, and that a provider has reasonably determined, have been earned but have not, at the time of the advance, been paid to the worker for work performed for or on behalf of an obligor or obligors.” Education financing is defined to include any credit “extended for the purpose of funding postsecondary education and costs of attendance at a postsecondary institution, including, but not limited to, tuition, fees, books and supplies, room and board, transportation, and miscellaneous personal expenses.”

The proposal contemplates registration through the Nationwide Multistate Licensing System (NMLS), including use of uniform forms (“MU1”). Applicants are not required to complete Section 10 (“Bank Account Information”) or Section 17 (“Qualifying Individuals”) of Form MU1. With respect to described business activities, in addition to any other relevant activities, education financers would need to designate “private student loan lending,” while those providing wage-based advances fall into the category of “other – consumer finance” on the form. Registrants would also need to disclose other trade names, designate contact employees, provide organizational charts (including indirect owners), management charts, and detailed business descriptions. Registrants would also need identify certain individuals, including principal officers, directors, managing members, general partners, individuals controlling (directly or indirectly) 10% or more, and responsible individuals. Identified individuals do not need to complete fingerprinting. Branch offices would also be registered, including identification of branch managers, separately using form MU3. Changes in information submitted would also be updated in NMLS. Annual financial reporting and disclosures, as well as fees are proposed too.

Outside of NMLS, the regulations, if finalized as proposed, would require an applicant for registration to submit directly to DFPI supplemental information including sample forms. Education financers would need to include copies of third-party contracts and agreements as well as marketing material and additional sample documents. With respect to those providing wage-based advances, the supplemental application would also include additional sample contracts and agreements used to provide the service as well as additional information regarding the product cycle.

Conclusion  

The registration requirements are not effective until DFPI completes the comment period and other rulemaking procedures. It is unclear what the effective date of any future finalized regulations would be. It is also not clear if current industry participants will be able to continue to operate while registrations are pending once the rules are finalized. We will continue to monitor the situation as the regulations proceed.

Application Deadline Looms Under California Debt Collection Licensing Act

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On September 25, 2020, California Governor Gavin Newsom approved Senate Bill 908 – enacting the Debt Collection Licensing Act (DCLA). The DCLA, which takes effect January 1, 2022, requires a person or entity engaging in the business of debt collection in California to be licensed and provides for regulatory oversight of debt collectors by the Department of Financial Protection and Innovation (DFPI). Pursuant to the DCLA, debt collectors who submit an application by Dec. 31, 2021 may continue to operate in California pending the denial or approval of their application. On April 23, 2021, the Commissioner of the DFPI (the Commissioner) issued proposed regulations (the Regulations) to adopt procedures for applying for a debt collection license under the DCLA. On June 23, 2021, after consideration of public comments, the Commissioner issued a Notice of Modifications to the Regulations (the Modifications). On November 15, 2021, the Commissioner issued a second Notice of Modifications to the Regulations (the Additional Modifications).

The Regulations

The Regulations – among other things –  define relevant terms, include information regarding application procedures, and contain other miscellaneous information regarding licensing. The definition of “debt collector” was substantially the same as the broad definition under the enacted DCLA (which in turn is very similar to the Rosenthal FDCPA definition) and encompasses a wide array of activity in relation to consumer debt, including mortgage debt. Likewise, the regulations define “debt buyer” identical to the existing definition in Section 1788.50 of the Civil Code, which contains an exception for purchasers of a loan portfolio predominantly consisting of consumer debt that has not been charged off. See our prior post on the DCLA for more information regarding the scope of the licensure requirement.

The Regulations designate NMLS for the submission and processing of applications and reference and rely upon uniform NMLS forms and procedures. The application process includes completion of the NMLS uniform licensing form (MU1), including by any affiliates to be licensed under the same license. The application process includes collection of information regarding other trade names, web addresses used by the applicant, contact employees, organizational information (including information on any indirect owners), a detailed statement of business activities, certificates of good standing, and sample dunning letters. Applicants do not need to provide bank account information in Section 10 of Form MU1 or information on a qualifying individual in Section 17 of Form MU1. Fingerprinting (which is processed outside of NMLS), criminal history checks, and credit report authorizations are required for certain related individuals, including officers, directors, managing members, trustees, responsible individuals, and any individual owning directly or indirectly 10% or more of the applicant. An investigative background report is also required for any such individual who is not residing in the United States. Branches must also be licensed through NMLS uniform forms (MU3). Notice and additional filing requirements apply upon any change in the information submitted. The Regulations also contain surety bond requirements and outline the Commissioner’s authority in reviewing and examining applicants.

First Notice of Modification to the Regulations

On June 23, 2021 the Commissioner issued the Modifications which made several changes to the Regulations including, revising the definition of “applicant” to make clear that an affiliate who is not applying for a license is not an “applicant” – this revision, however, does not seem to impact the ability of applicants to include affiliates under a single license. Further, the Modifications added an English language requirement for documents filed with the DFPI. The Modifications also eliminated certain requirements to provide the Commissioner with additional copies of documents submitted through NMLS and otherwise revised requirements to allow information to be processed predominately through NMLS. The Modifications also eliminated the need to file certain fingerprinting documents in NMLS. Additionally, the Modifications added a requirement to explain derogatory credit accounts for any individual subject to credit reporting requirements. The Modifications also removed requirements that applicants provide information concerning compliance reporting and audit structure, the extent to which they intend to use third parties to perform any of their debt collection functions, that applicants file a copy of their policies and procedures with the NMLS, and certain annually collected financial information. The Modifications also eliminate the Commissioner’s ability to modify surety bond amounts.

Second Notice of Modification to the Regulations

On November 15, 2021 the Commissioner issued the Additional Modifications to the Regulations which amended the definitions of “branch office” and “debt collector.” “Branch office” was amended to mean any location other than the applicant’s or licensee’s principal place of business so long as “activity related to debt collection occurs” at that location and that the location is “held out to the public as a business location or money is received at the location or held at the location.” The Additional Modifications state that “holding a location out to the public” includes the receipt of postal correspondence and meeting with the public at the location, placing the location on letterhead, business cards, and signage, or making “any other representation to the public that the location is a business location.”

The definition of “debt collector” was amended to reference the definition set forth in the DCLA, rather than actually defining the term. Thus, any future revisions to the DCLA definition will automatically apply to the regulations as well.

Conclusion  

Debt Collection agencies and participants in California should anticipate additional regulations from the DFPI as aspects of the DCLA continue to be hammered out – in the interim any entity subject to licensing who has not done so already should submit an application before end of year to ensure continued operations.

California, New York Create Disclosure Requirements for Commercial Financing Transactions

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A&B ABstract:

As a general matter, state regulation of commercial lending is relatively light, and few states impose licensing requirement on commercial loan origination.  In two noteworthy state developments, however, California and New York will require loan “providers” to furnish certain consumer-like disclosures to prior to the consummation of commercial financing transactions.

The California requirements will not take effect until the effective date of final implementing regulations promulgated by the California Department of Financial Protection and Innovation (DFPI), which has not yet occurred.  The New York requirements take effect on January 1, 2022.  Notably, both laws exempt commercial financing secured by real property, but it is unclear whether mezzanine lending is included in such exemptions.

The New York Law

The New York law requires “providers” of commercial credit to provide Truth-in-Lending Act-like disclosures to applicants at the time it extends a specific offer of the commercial financing in amounts of $2,500,000 or less.  “Providers” include both lenders and brokers.  The NY law applies to closed end financing, open-end financing, sales- based financing, including merchant cash advances and factoring transactions.

Exemptions:

The NY Law provides a de minimis exemption, “for any person or provider who makes no more than five commercial financing transactions in [New York] in a twelve-month period.” Further, “Financial institutions”, which include banks, and certain other chartered depository institutions authorized to conduct business in New York, are also exempt from the new commercial loan disclosure law, but the subsidiaries or affiliates of such exempt financial institutions are not exempt.     Commercial mortgage financings over $2,500,000 are exempt from the law as are transactions secured by real property.  It is unclear whether mezzanine lending in amounts of $2,500,000 or less would be covered by the new law.

Required disclosures:

The NY law requires providers to furnish the following type of disclosures, depending upon the form of the transaction:

  • The total amount of the commercial financing (or maximum amount of available credit) and, if different, the disbursement amount;
  • The finance charge;
  • The annual percentage rate or APR, calculated largely in accordance with TILA and Regulation Z;
  • The total repayment amount;
  • The term of the financing;
  • The amounts and frequency of payments;
  • A description of all other potential fees and charges;
  • A description of any prepayment charges; and
  • A description of any collateral requirements or security interests.

The California Law

The California law  (SB 1235), which was signed into law on September 18, 2018 but is not effective until the DFPI promulgates final regulations, amends the California Finance Lenders Law (CFL) to require “providers” licensed under the CFL who facilitate “commercial financing” to a “recipient” to disclose to the recipient at the time of extending a specific offer of commercial financing specified information relating to the transaction and to obtain the recipient’s signature on that disclosure before consummating the commercial financing transaction.

Applicability:

The California law otherwise applies to, among other things, commercial loans, certain commercial open-end plans, factoring, merchant cash advances, and commercial asset- based lending.  Unlike the NY law which applies to brokers as well as lenders,  under the California law “provider”  is primarily limited to entities extending credit, such as lender/originators, but also includes a non-bank partner in a market place lending arrangement who facilitates the arrangement of financing through a financial institution.   Further, the California law defines “recipient” as the applicant of commercial credit of $500,000 or less.

Exemptions:

The California law exempts, among others, depository institutions and entities that make no more than one commercial financing in a 12 month period or who make five or fewer commercial financing transactions in California in a 12 month period that are incidental to the business of the entity relaying on the exemption.

Further, the California law does NOT apply to transactions greater than $500,000 or to real estate-secured commercial loans or financings.  It is unclear, however, whether mezzanine lending in amounts of $500,000 or less would be covered by the California law.

Required disclosures:

Once implemented, the California law will require the provider to disclose, among other information:

  •  The total amount of funds provided;
  • The total cost of the financing;
  • The term or estimated term;
  • The method, frequency and amount of payments; and
  • A description of prepayment penalties.
Implementation:

The DFPI has issued several sets of proposed regulations and has solicited public comment on these regulations.  The DFPI issued its most recent version of the regulations for public comment on October 12, 2021, and the comment period ended on October 27, 2021.  It is uncertain when the DFPI intends to promulgate final regulations with a mandated effective date.

The link to the California law is below:

Takeaway:

Up to this point, state regulation of commercial lending has been relatively light.  The California and New York laws are not only burdensome to lenders, they could be harbingers of developments to come in this area.