Regulation
Regulators Say ‘Sandboxes’ Work
October 22, 2018
At the regulatory technology (or RegTech) sessions at Money 20/20 yesterday, toy shovels seemed glaringly absent given the number of times the word “sandbox” was used. Of course, panelists were referring to a regulatory sandbox.
Nick Cook, Head of RegTech and Advanced Analytics at the Financial Conduct Authority in the UK, discussed his experience facilitating regulatory sandboxes. According to Cook, a regulatory sandbox is an arrangement between a company and a regulator where, in order to test the viability of a new business or product, the regulator grants some kind of allowance to the company for a fixed period of time in exchange for the regulator’s ability to observe carefully how the new business or technology works and behaves in the market.
“Whether you call it ‘sandbox’ or not, are you going to just talk about it, or are you going to encourage actual experimentation?” Cook posited to other regulators broadly. “Don’t kid yourself that standing still is an option.”
“I hope that states continue these sandboxes,” said Chris Camacho, President & CEO of the Greater Phoenix Economic Council.
Seated on two of the panels on regulation was Paul Watkins, who, as Civil Litigation Division Chief at the Arizona Office of the Attorney General, drafted and advocated for legislation that established the first Fintech Sandbox in the US. Watkins said that coordination between the federal and state regulators will be important moving forward.
One of the panelists was Melissa Koide, CEO of FinRegLab, a research organization that is designed to test new technologies to inform public policy, much like a sandbox.
“Regulators have anxiety about liability if something goes wrong,” Koide said. And she that therefore dialogue among regulators is very helpful, especially the ability for regulators to learn together.
“Regulators can’t innovate if they can’t experiment,” said JoAnn Barefoot, who moderated a few of the sessions. Barefoot is the co-founder of Hummingbird Regtech, a platform for anti-money laundering.
How Regulators Like to Be Approached
October 22, 2018
On the first day of Money 20/20 yesterday, a panel of current and former regulators discussed how the regulatory environment can help emerging fintech companies and how the leaders of such companies ought to interact with regulators. “How do regulators want to be approached?” was a question presented to the panel.
“The first person I hear from I don’t listen to,” said Paul Watkins, Director of the Office of Innovation for the U.S. Bureau of Consumer Financial Protection (BCFB). He clarified with deBanked after the panel discussion that this is in reference to his previous regulatory role as Civil Litigation Division Chief at the Arizona Office of the Attorney General. He said that this “first person” he doesn’t listen to refers to the lobbyist. Watkins continued: “The second person might have something interesting to say and the person who is quiet maybe knows what’s going on, and I’m interested to learn from them.” The “second person,” he explained, might be the CEO of a company and the “quiet person,” he said, would often be a non-senior level employee at a company who really sees what’s happening on the ground level.
Melissa Koide, who once served as the U.S. Treasury Department’s Deputy Assistant Secretary for Consumer Policy, said that she always appreciated hearing directly from the innovators themselves about their relationships with banks.
“It can be valuable to make trips to [visit regulators,]” Koide said.
Koide is now CEO of FinRegLab, a financial services research organization that examines how technology and data can help achieve public policy that leads to a more efficient and inclusive marketplace.
Chris Camacho, President and CEO of the Greater Phoenix Economic Council said that elected officials want to hear from industry leaders.
“Engage [legislators] thoughtfully and educate them,” Camacho said.
NJ Legislature Aims to Classify Merchant Cash Advance as a Loan in New Disclosure Bill
October 15, 2018
S2262 in New Jersey, a bill to require disclosures in small business lending, was amended this afternoon to define merchant cash advances as small business loans for the purposes of disclosure.
Banks and equipment leasing companies are exempt from the bill.
You can listen to the hearing here. Debate on S2262 begins at the 6 minute, 12 second mark.
The bill’s author (image at right) is Democratic Senator Troy Singleton who represents New Jersey’s 7th legislative district.
Testifying on Monday’s hearing against the bill were Kate Fisher of the Commercial Finance Coalition and PJ Hoffman of the Electronic Transactions Association.
New Jersey Moves to Regulate Small Business Loan Disclosures and Brokers
October 15, 2018
A committee within the New Jersey State Senate convened today at 1:30pm to discuss S2262, a new small business loan disclosure bill. Similar to SB1235 in California, this bill would require all of the following on small business loan contracts less than $100,000:
The APR(This was removed during the committee hearing)- The annualized interest rate
- The finance charge
- The maximum credit limit available
- The payment schedule
- A list of all broker fees and a description of the broker’s relationship with the lender and any conflicts of interest the broker may have
- These terms must be presented before a business accepts a loan
In addition, any change to the terms that would significantly affect the responsibilities or obligations of the small business concern under the loan must be noticed 45 days in advance.
During the hearing, the bill was amended to define merchant cash advances as small business loans. Kate Fisher of Hudson Cook, LLP who represented the Commercial Finance Coalition (CFC) during the hearing, strongly opposed that amendment. The CFC is a trade association representing small business lending and MCA companies.
Also testifying against it was PJ Hoffman of the Electronic Transactions Association. Other Trade groups are gearing up to oppose the bill as well, deBanked has learned.
The bill was voted through the committee and will continue to move forward.
Kate Fisher’s testimony has been transcribed below:
Senator Pou and committee members: Thank you for the opportunity to present testimony today regarding business loan disclosures.
My name is Kate Fisher and I am here today on behalf of the Commercial Finance Coalition, a group of responsible finance companies that provide capital to small and medium-sized businesses through innovative methods. I also am an attorney who helps providers of commercial financing comply with state and federal law.
The Commercial Finance Coalition supports efforts to make business financing more transparent.
The problem is the proposed amendment would define a merchant cash advance as a loan. A merchant cash advance is not a loan.
We all know how a loan works – the lender advances money and the borrower promises to pay it back.
A merchant cash advance is a factoring transaction, in which a business sells a percentage of its future receivables at a discount.
Take for example, a pizza shop. The pizza oven breaks and the owner needs cash to replace it.
In a loan, the pizza shop borrows the money and promises to pay the money back to the lender with interest.
In a merchant cash advance, the pizza shop sells its future receivables to a merchant cash advance company. In exchange for the money to buy that pizza oven, the merchant cash advance company will take 10% of each dollar the pizza shop makes.
If the pizza shop’s sales go down, it will pay less. If the pizza shop’s sales go up, it will pay more. And if the pizza shop is damaged by a hurricane and has to close for repairs, it will pay nothing until it can reopen its doors.
This uncertainty of repayment is why a merchant cash advance is not a loan – the pizza shop in our example, only pays if it sells pizza. Courts have overwhelmingly agreed that a merchant cash advance is not a loan. To quote a recent court decision:
“Receivables purchasing is an accepted form of business transaction, and is not a loan.”
Because a merchant cash advance is not a loan, and there is no fixed payment term, requiring an APR or annual interest rate disclosure would be misleading. For a small business looking for financing, these types of disclosures would only add confusion.
I’m very optimistic that New Jersey can lead the way in providing businesses with disclosures that are helpful – and not misleading.
Thank you.
California Now Requires Mandatory Disclosures on Commercial Finance
October 1, 2018California Governor Jerry Brown has signed SB 1235.
As of Jan 1, 2019, commercial finance companies in California will be required to disclose the following on their contracts:
(1) The total amount of funds provided.
(2) The total dollar cost of the financing.
(3) The term or estimated term.
(4) The method, frequency, and amount of payments.
(5) A description of prepayment policies.
(6) The total cost of the financing expressed as an annualized rate.
To find out if this bill affects your company, contact an attorney.
Renaud Laplanche Barred From the Securities Industry
September 28, 2018
The SEC announced today that it charged LendingClub Asset Management, formerly known as LendingClub Advisors LLC (LCA), and its former president and co-founder Renaud Laplanche, with fraud – for improperly using fund money to benefit LendingClub Corporation, LCA’s parent company. LCA, Laplanche and Carrie Dolan, LCA’s former CFO, also were charged with improperly adjusting fund returns.
LCA, Laplanche and Dolan have agreed to settle the SEC’s charges against them and will pay penalties of $4 million, $200,000, and $65,000, respectively. The SEC also barred Laplanche from the securities industry for three years. LCA, Laplanche, and Dolan agreed to the entry of the SEC’s order without admitting or denying the agency’s findings.
This follows Laplanche’s ouster from LendingClub in May 2016 amid revelations of falsified loan records and conflicts of interest under Laplanche’s leadership. He is now the CEO of Upgrade, a San Francisco-based online lender, and he has been hailed recently for his resilience for making such a quick comeback.
A representative from Upgrade provided deBanked with a statement from Laplanche:
“I am pleased to have worked out a settlement with the SEC to put to rest any issues related to compliance lapses that might have occurred under my watch at Lending Club. Consistent with SEC policy, I have agreed not to admit nor deny the specific narrative of the events contained in the settlement order. I would like, however, to provide additional context:
1. To the extent there was an imbalance between 60-month and 36-month loans in one of the LCA funds as compared to its initial target, the specific 36/60-month balance was disclosed to investors every month.
2. Any manual adjustments used by the LCA team as part of the funds valuation methodology had a total net impact of 0.08% of the funds value over 5 years, and I strongly believe those adjustments were made by the LCA team in good faith.
In any event, I am glad that we can now put these issues behind us and focus on the important goals of making credit more affordable to consumers and delivering attractive returns to investors through disciplined underwriting and exciting product innovation. With the benefit of my prior experience, I feel better equipped to establish a strong culture of compliance and effective internal controls under the supervision of capable professionals.”
LendingClub, the actual company, or LendingClub Corporation, was spared any charges from the SEC because of its cooperation with the agency. The SEC press release explains below:
“The SEC’s Enforcement Division determined not to recommend charges against LendingClub Corporation, which promptly self-reported its executives’ misconduct following a review initiated by its board of directors, thoroughly remediated, and provided extraordinary cooperation with the agency’s investigation. LCA also reimbursed approximately $1 million to investors who were adversely impacted by the improperly adjusted monthly returns.”
Lending Club, which Laplanche brought public 2014, did not respond in time to questions before publication.
Congressman Cleaver’s Findings on Fintech Lending Mixed
August 30, 2018
Congressman Emanuel Cleaver, II from Missouri announced findings earlier this month from a year-long inquiry he initiated into fintech small business lending practices and minorities. His initial inquiry was to determine if merchant cash advance companies had mechanisms in place to avoid discriminatory lending practices.
Cleaver concluded that some common practices in non-bank underwriting processes lend themselves to discrimination against minority business owners. One such practice is using a merchant’s personal credit score to determine a business’ credit worthiness, which the report maintains is unfair because “a personal credit score has little bearing on a business model or the owner’s business acumen, and using it unfairly punishes minority business owners who may not have had the same opportunities to build credit.” Another complaint is the common practice of having merchants sign forced arbitration clauses that forbid the borrower to take the lender to court.
The companies that he surveyed included OnDeck, Kabbage, Fora Financial, Lending Club, Biz2Credit and LendUp, even though Lendup only does consumer lending. And OnDeck, Kabbage and Lending Club don’t offer a cash advance product. Still, they make non-bank business loans.
The report also mentioned that algorithms used by some of these companies could inadvertently be discriminatory. That’s because they have the ability to incorporate the number of criminal records and bankruptcies in the merchant applicant’s zip code when making a funding decision. And these numbers tend to be higher in minority neighborhoods.
However, the report also highlighted some good practices, such as including a third party in the lending process to protect from engaging in unintentional discriminatory behavior.
“From the responses gathered,” the report reads, “it has become increasingly clear that a majority of the companies have taken some measure to prevent blatant discrimination. Nevertheless, additional protections are very much needed.”
“The initial findings are clear as day, Congressman Cleaver said in a statement about the report. “We need to further understand how lenders may be intentionally or unintentionally offering higher interest rates to minorities and underserved communities, and work to implement industry-wide best practices.”
The California Business Loan & MCA Disclosure Bill Has Passed
August 30, 2018The bill has passed. With the governor’s signature, all business loan contracts and merchant cash advance contracts in California will soon require a uniform set of formal disclosures including an annualized rate of the total cost. The precise formula for that rate will be determined by the state’s regulatory agency, the Department of Business Oversight.
Update: The bill’s death in committee was challenged by the bill’s author, Senator Steve Glazer, and ultimately allowed to come up for a vote after he complained to the senate majority leader that a committee’s decision is merely a recommendation, not a deciding factor on the bill itself. At 2:10 AM EST, it passed.
Update: The bill has died in the Senate Banking Committee. Daniel Weintraub, who serves as chief of staff to the bill’s author, tweeted after midnight eastern time that the bill was not moving forward.
Thanks to all who supported small business and #SB1235. Unfortunately the Senate Banking Committee killed the bill tonight. We fell one vote short of the four we needed to send the bill to the Senate floor. https://t.co/30ztdW2LbD
— Daniel Weintraub (@DMWeintraub) September 1, 2018
Update: The bill passed the Assembly unopposed and is slated for a late night vote by the Senate Banking Committee.
Update 8/31/18: Today is the last day for the legislature to pass this bill. We will keep you updated
California’s bill to mandate certain disclosures on business loan and merchant cash advance contracts is looking a little bit worse. The Annualized Cost of Capital method (Explained here) that some folks in the industry were accepting of, has been scrapped in favor of whatever formula a state regulator decides to pick. That means if the Commissioner of Business Oversight decides on an APR disclosure, which many industry trade groups believed they had already successfully lobbied against, all loans and non-loans alike would have to report an APR, a mathematical impossibility for a product like merchant cash advance. At present, however, all that is known is that the Commissioner’s choice must be an annualized metric.
According to Bloomberg, the amended version of the bill needs to get approval in both the Assembly and the Senate by Friday before the legislative session ends.
Trade associations that have weighed in on this bill include the Electronic Transactions Association, Commercial Finance Coalition, Small Business Finance Association, and the Innovative Lending Platform Association.
You can view all of our previous coverage about the bill here.
