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Court vacates mandatory disclosures and 30-day credit linking restriction in Prepaid Accounts Rule
On December 30, the U.S. District Court for the District of Columbia granted a payment company’s motion for summary judgment against the CFPB, vacating two provisions of the agency’s Prepaid Account Rule: (i) the short-form disclosure requirement “to the extent it provides mandatory disclosure clauses”; and (ii) the 30-day credit linking restriction. As previously covered by InfoBytes, the company filed a lawsuit against the Bureau alleging, among other things, that the Bureau’s Prepaid Account Rule exceeds the agency’s statutory authority “because Congress only authorized the Bureau to adopt model, optional disclosure clauses—not mandatory disclosure clauses like the short-form disclosure requirement.” The Bureau countered that it had authority to enforce the mandates under federal regulations, including the Electronic Fund Transfer Act (EFTA), TILA, and Dodd-Frank, arguing that the “EFTA and [Dodd-Frank] authorize the Bureau to issue—or at least do not foreclose it from issuing—rules mandating the form of a disclosure.” The Bureau also claimed that its general rulemaking power under either TILA or Dodd-Frank provides authority for the 30-day credit-linking restriction.
With respect to the mandatory disclosure clauses of the short-form requirement in 12 CFR section 1005.18(b), the court concluded, among other things, that the Bureau acted outside of its statutory authority. The court stated that “Congress underscored the need for flexibility by requiring the Bureau to ‘take account of variations in the services and charges under different electronic fund transfer systems’ and ‘issue alternative model clauses’ for different account terms where appropriate” and it could not “presume—as the Bureau does—that Congress delegated power to the Bureau to issue mandatory disclosure clauses just because Congress did not specifically prohibit them from doing so.”
In striking the mandatory 30-day credit linking restriction under 12 CFR section 1026.61(c)(1)(iii), the court determined that “the Bureau once again reads too much into its general rulemaking authority.” First, the court determined that neither TILA nor Dodd-Frank vest the Bureau with the authority to promulgate substantive regulations on when consumers can access and use credit linked to prepaid accounts. Second, the court deemed the regulatory provision to be a “substantive regulation banning a consumer’s access to and use of credit” under the disguise of a disclosure, and thus invalid.
Brainard addresses FedNow and other payment issues
On February 5, Federal Reserve Governor Lael Brainard spoke at the “Symposium on the Future of Payments” to discuss benefits and risks associated with the digitalization of payments and currency. Noting that some of the new players in this space are outside financial regulatory guardrails and offer new currencies that “could pose challenges in areas such as illicit finance, privacy, financial stability, and monetary policy transmission,” Brainard stressed the importance of assessing new approaches and redrawing existing parameters. Emphasizing, however, that no federal agency has broad authority over the payments systems, Brainard stated that Congress should review how retail payments are regulated in the U.S., given the growth in ways that money is able to move around without the need for a financial intermediary. Banking agencies may oversee nonbank payments “to the extent there is a bank nexus” or bank affiliation, Brainard noted, however, she cautioned that “this oversight will be quite limited to the extent that nonbank players reduce or eliminate the nexus to banks, such as when technology firms develop payments services connected to digital wallets rather than bank accounts and rely on digital currencies rather than sovereign currencies as the means of exchange.” According to Brainard, “a review of the nation’s oversight framework for retail payment systems could be helpful to identify important gaps.”
Among other topics, Brainard stated that the Fed is currently reviewing nearly 200 comment letters concerning the proposed FedNow Service announced last summer, which would “facilitate end-to-end faster payment services, increase competition, and ensure equitable and ubiquitous access to banks of all sizes nationwide.” (Covered by InfoBytes here.) Brainard also discussed the possibility of creating a central bank digital currency (CBDC). While noting that the “prospect for rapid adoption of global stablecoin payment systems has intensified calls for central banks to issue digital currencies in order to maintain the sovereign currency as the anchor of the nation’s payment systems,” Brainard stressed the importance of taking into account private sector innovations and considering whether adding a new form of central bank liability would improve the payment system and reduce operational vulnerabilities from a safety and resilience perspective. She noted that the Fed is “conducting research and experimentation related to distributed ledger technologies and their potential use case for digital currencies, including the potential for a CBDC.”
Lawsuit says Prepaid Accounts Rule is “arbitrary and capricious”
On December 11, a payments company filed a lawsuit against the CFPB in the U.S. District Court for the District of Columbia alleging that the Bureau’s Prepaid Account Rule (Rule), which took effect April 1 and provides protections for prepaid account consumers, exceeds the agency’s statutory authority and is “arbitrary and capricious” under the Administrative Procedures Act (APA). The company further asserts that the Rule violates its First Amendment rights by requiring it to make confusing disclosures that contain categories not relevant to the company’s products. According to the complaint, the Rule mandates that the company send “short form” fee disclosures to customers that include references to fees for ATM balance inquiries, customer service, electronic withdrawal, international transactions, and other categories, and “prohibits [the company] from including explanatory phrases within the disclosure box to describe the nature of these fee categories.” These disclosures, the company asserts, have confused many customers who mistakenly believe the company charges fees to access funds stored as a balance with the company, to make a purchase with a merchant, or to send money to friends or family in the U.S. The company also claims that the Bureau erroneously lumped it into the same category as providers of general purpose reloadable cards (GPR cards), and argues that the Rule ignores how prepaid cards fundamentally differ from digital wallets, which has resulted in several unintended consequences.
The company asserts that the Rule is unlawful and invalid under the APA and the Constitution for three principal reasons:
- The Rule contravenes the Bureau’s statutory authority by (i) establishing a mandatory and misleading disclosure regime that is not authorized by federal law; and (ii) “impos[ing] a 30-day ban on consumers linking certain credit cards to their prepaid account—a prohibition the law nowhere authorizes the Bureau to impose.”
- Even if the Bureau possesses the statutory authority it claims to have, the rulemaking process was “fundamentally flawed” due to its one-size-fits-all Rule that misunderstands the different characteristics of digital wallets compared to GPR cards. By treating digital wallets as if they are GPR cards, the Rule violates the APA’s reasoned decision-making requirement. Additionally, the Rule is marked by “an insufficient cost-benefit analysis that failed to properly weigh the limited benefits consumers might derive from the Rule against the costs” stemming from the Rule’s changes.
- The Rule violates the First Amendment by failing to satisfy the heightened standard that a law or regulation “directly advances a substantial government interest” because it requires the company to makes certain disclosures that are irrelevant to its digital wallet product. Moreover, the Rule’s disclosure obligations “functionally impair the speech in which [the company] might otherwise engage” by mandating that it provide confusing and misleading disclosures about the nature of its offerings.
The complaint asks that the Rule be vacated and declared arbitrary, an abuse of discretion, not in accordance with the law, and unconstitutional, and additionally seeks injunctive relief, attorneys’ fees and costs.
CFTC Issues Primer on Virtual Currencies, Claims Certain Virtual Tokens Fall Under Its Oversight
On October 17, the U.S. Commodity Futures Trading Commission (CFTC) announced the release of “A CFTC Primer on Virtual Currencies” (Primer) issued by its LabCFTC division. As previously discussed in Infobytes, the LabCFTC initiative rolled out in May of this year to engage innovators in the financial technology industry to promote responsible fintech innovation within regulated CFTC markets. In this Primer—a first in a series—the CFTC discusses potential use-cases for virtual currencies and outlines the agency’s role and oversight of virtual currencies. The Primer also highlights the risks associated with virtual currencies, such as (i) the susceptibility of “digital wallets” to cybersecurity hacks; (ii) inadequate safeguards and other customer protection related systems on virtual currency exchanges; and (iii) the susceptibility of virtual currencies to Ponzi schemes and other types of frauds.
The CFTC noted that there’s no inconsistency between the SEC’s analysis that Initial Coin Offerings or Token Sales may be subject to federal securities law (see previous InfoBytes coverage here) and CFTC’s determination that virtual currencies are commodities and virtual tokens “may be commodities or derivatives contracts, depending on the particular facts and circumstances.” Last month, as discussed in InfoBytes, the CFTC also filed its first-ever antifraud enforcement action for activities involving Bitcoin investment solicitations.
Texas Appeals Court Cites Khoury, Dismisses Trial Court’s Summary Judgment Under UETA
On October 3, a three-judge panel of a Texas Court of Appeals reversed and remanded, while affirming in part, a trial court’s decision concerning an alleged breach of contract over a $230 million sale agreement. On appeal were three issues, including a challenge to the grounds on which the trial court granted summary judgement under the Uniform Electronic Transactions Act (UETA). The trial court concluded that the “parties did not agree to conduct business electronically and that the alleged contract did not contain a valid electronic signature.” But the panel reversed the decision, holding that an agreement between parties to conduct transactions by electronic means “need not be explicit” under UETA, and finding that the parties’ email negotiations constituted “at least some evidence that the parties agreed to conduct some of their transactions electronically.” and The panel also cited their earlier decision in Khoury v. Tomlinson, that was previously discussed in InfoBytes, to address the question of whether the emails between the two parties were signed electronically. Khoury ruled that an email satisfied the writing requirement because it was an electronic record, and that the header, which included a “from” field constituted as a signature because that field served the same “authenticating function” as a signature block. Consequently, because there was “at least some evidence that the relevant emails were signed as defined in UETA,” the trial court in this matter erred in granting summary judgment.
Further, because the panel found that there still remain questions regarding whether the parties actually formed an agreement concerning the sale of assets, the panel stated they were unable to determine “as a matter of law, under the particular facts of this case, whether such a contract is illusory.” Thus, the trial court erred in granting summary judgment on these grounds as well.
The remainder of the trial court’s judgments were affirmed, and the case was remanded for further proceedings consistent with the opinion.
Money Transmitter Licensing Changes in New Hampshire and Washington for Virtual Currencies
On August 1, New Hampshire HB 436 went into effect, “exempting persons using virtual currency from registering as money transmitters” under the state’s money transmitter licensing laws. The new exemption applies to persons who “engage in the business of selling or issuing payment instruments or stored value solely in the form of convertible virtual currency” or “receive convertible virtual currency for transmission to another location.” However, the exemption provides that such persons are “subject to” certain state consumer protection laws.
Separately, Washington SB 5031 took effect on July 23, amending the state’s Uniform Money Services Act as it relates to money transmitters and currency exchanges. With respect to virtual currencies, the amendments, among other things: (i) define “virtual currency”; (ii) subject virtual currencies to the state’s money transmitter licensing laws (the definition of “money transmission” now includes virtual currency transmissions); (iii) require businesses that “store virtual currency on behalf of others” to provide the state with “a third-party security audit of all electronic information and data systems” when applying for a money transmitter license; (iv) require virtual currency licensees to “hold like-kind virtual currencies of the same volume . . . obligated to consumers”; and (v) require virtual currency licensees to provide certain disclosures “to any person seeking to use the licensee’s products or services,” including a schedule of fees and charges, and whether the product or services are insured.
SEC Issues Investigative Report: Federal Securities Laws Apply to Virtual Organizations
On July 25, the SEC issued an investigative report stating that federal securities laws apply to anyone who offers and sells securities in the U.S., regardless of the manner of distribution or whether dollars or virtual currencies are used to purchase the securities. The SEC’s Report of Investigation (Report) advises users to make sure they are compliant with federal securities laws when raising capital through Decentralized Autonomous Organizations (DAO) or other forms of distributed ledgers or blockchain technology. These offering are often referred to as “Initial Coin Offerings” (ICOs) or “Token Sales.”
The Report originates from an Enforcement Division inquiry into whether the DAO—and affiliated entities—“violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for ‘Ether,’ a virtual currency.” According to the SEC, the DAO, which has been described as a “crowdfunding contract,” has not met any of the specific Regulation Crowdfunding exemption requirements issued earlier this year by the agency. These regulations were previously discussed in InfoBytes. In its Report, the SEC stated that the individuals involved in a 2016 virtual currency offering that was later hacked will not face charges, but will rather serve as a warning to the industry that people who offer and sell securities in the U.S. must follow the law. In light of this discussion, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to educate investors about the benefits and risks of ICOs, which promoters have begun to use to sell virtual currencies.
“Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws,” said William Hinman, SEC Director of the Division of Corporation Finance.
CFTC Approves First Digital Currency Derivatives Exchange
On July 24, the Commodity Futures Trading Commission (CFTC) announced its approval, by unanimous vote, of the first digital currency derivatives exchange under the Commodity Exchange Act. The CFTC issued a letter and order granting the registration, allowing the company to provide clearing services for fully-collateralized digital currency swaps, but noted that the authorization to provide clearing services for fully-collateralized digital currency swaps did not constitute or imply a CFTC endorsement of the use of digital currency generally, or bitcoin specifically. Based on the company’s representations related to having collateral already on deposit to cover the maximum possible loss, the CFTC exempted the company from certain regulations calling for, among other things, monthly stress-testing and specific daily reporting requirements. The company initially plans to clear bitcoin options.
Noncash Payment Growth Highlighted in Sixth Federal Reserve Payments Study
On June 30, the Board of Governors of the Federal Reserve issued its sixth payments study entitled The Federal Reserve Payments Study 2016: Recent Developments in Consumer and Business Payment Choices. The study includes data on business and consumer noncash payments made in the United States in 2015. Among other things, the study details the differences between business and consumer payments in 2015 compared to those from 2000, general-purpose payment card use in 2015, and increases in use of alternative payment methods.
According to the report, the most popular noncash payment types among consumers were, in descending order: non-prepaid debit cards, general-purpose credit cards, checks, and finally, ACH debit transfers. For businesses, however, ACH credit transfers were the most popular, then checks, general-purpose credit cards, and non-prepaid debit cards. Consumers wrote fewer than half the number of checks in 2015 than they did in 2000 but almost doubled the number of noncash payments that they made. Businesses also cut check-writing by more than half but differed from consumers by more than doubling the number of ACH transfers that they initiated during the same period.
General-purpose or “network-branded” cards accounted for more than 65 percent of noncash payments in 2015. The data showed that 60 percent of these card accounts carried revolving debt, while 40 percent of accounts were paid in full each month.
Information on fraudulent payments also was collected and should be available in the third quarter of this year.
Illinois Finalizes Digital Currency Regulatory Guidance
On June 13, the Illinois Department of Financial and Professional Regulation (IDFPR) issued final guidance on the regulatory treatment of digital currencies with an emphasis on decentralized digital currencies. (See IDFPR news release here). As previously covered in InfoBytes, the IDFPR requested comments on its proposed guidance in December of last year in order to devise the proper regulatory approach to digital currency in compliance with money transmission definitions in the Illinois Transmitters of Money Act, 205 Ill. Comp. Stat. 657/1, et seq. (TOMA).
The “Digital Currency Regulatory Guidance” clarifies that digital currencies are not money under TOMA, and therefore, those engaged in the transmission of digital currencies are not generally required to obtain a TOMA license. The IDFPR noted, however, that “should transmission of digital currencies involve money in a transaction, that transaction may be considered money transmission” and suggested persons engaging in such transactions request a determination regarding whether or not the activity will require a TOMA license.
To provide additional clarity, the guidance includes examples of common types of digital currency transactions that qualify as money transmissions, as well as examples of activities that do not qualify as money transmission.