SEC Brings Enforcement Action Against Two Companies Related to Initial Coin Offerings

On September 29, 2017, the U.S. Securities and Exchange Commission filed a complaint in federal court against REcoin Group Foundation, LLC (“REcoin”); DRC World, Inc., also known as Diamond Reserve Club (“DRC”); and their principal, Maksim Zaslavskiy. The complaint alleges false and misleading statements and violations of securities laws in connection with initial coin offerings (“ICOs”) by the two companies.

According to the SEC, the defendants raised funds from hundreds of investors by offering nonexistent digital “tokens” or “coins” supposedly backed by investments in real estate (in REcoin’s case) and diamonds (in DRC’s case). The SEC further alleges that in order to evade securities laws, including registration requirements, the defendants styled the ICOs as sales in club memberships. The SEC’s complaint also alleges that the defendants made false and misleading statements including that:  defendants had raised as much as $4 million (instead of the $300,000 they actually raised); the underlying assets would be selected by the companies’ “experts” and “team of lawyers, professionals, brokers, and accountants” (when none had been hired or consulted); and DRC investors could expect 10% to 15% returns (when the investments were nonexistent). According to the SEC, the defendants eventually terminated the REcoin ICO by falsely claiming that the U.S. government required them to do so, when the SEC alleges that Mr. Zaslavskiy himself characterized offering the advertised tokens as “impossible.”

In a joint statement on REcoin’s and DRC’s websites, the companies responded:

We believe this action is the result of a lack of legal clarity as to when an ICO or a digital asset is a security. This lack of regulatory clarity was implicitly recognized by the SEC in its recent Report of Investigation of the Distributed Organization (“DAO”). While we disagree with the SEC’s claims that the tokens we sold are securities, and will vigorously defend ourselves, we are cooperating with the SEC in the hope of resolving this issue.

In the mentioned investigative report, the SEC concluded that whether an offer and sale of an interest in a virtual organization constitutes the offer and sale of a security depends on “the facts and circumstances” of the transaction, “regardless of the terminology used.” In July, the SEC Office of Investor Education and Advocacy also published an investor bulletin on the fraud risks posed by ICOs.

The SEC has announced that the U.S. District Court for the Eastern District of New York has granted an emergency order freezing the defendants’ assets.

CFPB Finalizes Payday Lending Rule

On October 5, 2017, the CFPB finalized its long-awaited rule on payday, vehicle title, and certain high-cost installment loans, commonly referred to as the “payday lending rule.” The final rule places ability-to-repay requirements on lenders making covered short-term loans and covered longer-term balloon-payment loans. For all covered loans, and for certain longer-term installment loans, the final rule also restricts attempts by lenders to withdraw funds from borrowers’ checking, savings, and prepaid accounts using a “leveraged payment mechanism.”

In general, the ability-to-repay provisions of the rule cover loans that require repayment of all or most of a debt at once, such as payday loans, vehicle title loans, deposit advances, and longer-term balloon-payment loans. The rule defines the latter as including loans with a single payment of all or most of the debt or with a payment that is more than twice as large as any other payment. The payment provisions restricting withdrawal attempts from consumer accounts apply to the loans covered by the ability-to-repay provisions as well as to longer-term loans that have both an annual percentage rate (“APR”) greater than 36%, using the Truth-in-Lending Act (“TILA”) calculation methodology, and the presence of a leveraged payment mechanism that gives the lender permission to withdraw payments from the borrower’s account. Exempt from the rule are credit cards, student loans, non-recourse pawn loans, overdraft, loans that finance the purchase of a car or other consumer product that are secured by the purchased item, loans secured by real estate, certain wage advances and no-cost advances, certain loans meeting National Credit Union Administration Payday Alternative Loan requirements, and loans by certain lenders who make only a small number of covered loans as accommodations to consumers.

The rule’s ability-to-repay test requires lenders to evaluate the consumer’s income, debt obligations, and housing costs, to obtain verification of certain consumer-supplied data, and to estimate the consumer’s basic living expenses, in order to determine whether the consumer will be able to repay the requested loan while meeting those existing obligations. As part of verifying a potential borrower’s information, lenders must obtain a consumer report from a nationwide consumer reporting agency and from CFPB-registered information systems. Lenders will be required to provide information regarding covered loans to each registered information system. In addition, after three successive loans within 30 days of each other, the rule requires a 30-day “cooling off” period after the third loan is paid before a consumer may take out another covered loan.

Under an alternative option, a lender may extend a short-term loan of up to $500 without the full ability-to-repay determination described above if the loan is not a vehicle title loan. This option allows three successive loans but only if each successive loan reflects a reduction or step-down in the principal amount equal to one-third of the original loan’s principal. This alternative option is not available if using it would result in a consumer having more than six covered short-term loans in 12 months or being in debt for more than 90 days on covered short-term loans within 12 months.

The rule’s provisions on account withdrawals require a lender to obtain renewed withdrawal authorization from a borrower after two consecutive unsuccessful attempts at debiting the consumer’s account. The rule also requires notifying consumers in writing before a lender’s first attempt at withdrawing funds and before any unusual withdrawals that are on different dates, in different amounts, or by different channels, than regularly scheduled.

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Industry Coalition Challenges CFPB Arbitration Rule in Court

On September 29, 2017, a coalition of bank and trade associations filed a federal court challenge to the Consumer Financial Protection Bureau’s (“CFPB” or the “Bureau”) arbitration rule. The industry group plaintiffs allege that the arbitration rule is illegal on four grounds, including that the CFPB’s actions are unconstitutional, and that the Bureau violated the Administrative Procedure Act (“APA”) in conducting and interpreting the arbitration study it used to justify the rule.

The Bureau published its final arbitration rule in July. As we have explained previously, the regulation would generally prohibit financial services businesses from including arbitration clauses in consumer contracts unless those arbitration clauses expressly permit class actions to proceed in court. In reaching the conclusion that the arbitration rule was justified, the CFPB relied on a study it conducted on the effects of consumer arbitration clauses in the financial services industry.

The lawsuit argues that the district court should invalidate the arbitration rule on four grounds:

  1. The structure of the Bureau, with its single director removable only for cause, is unconstitutional, and this unconstitutionality “fatally infected” the passage of the rule. This constitutional argument has been previously raised in the PHH case, which we have previously discussed.
  2. The Bureau’s study into the effects of mandatory arbitration does not properly support the rule under the APA,  because it improperly limited public participation, used improper methodologies, misconstrued the data, and did not address additional essential considerations.
  3. The Bureau’s interpretation of this study also violated the APA because its conclusions ran counter to the factual record the Bureau developed, and thus was arbitrary and capricious.
  4. Adoption of the arbitration rule violated the directive of the Dodd-Frank Act to implement a rule limiting the use of consumer arbitration clauses only if such a rule was in the public interest and advanced consumer welfare. Along similar lines, the Office of the Comptroller of the Currency recently published a report indicating that the arbitration rule would increase credit costs for consumers.

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CFPB Releases Results of Survey on U.S. Consumer Financial Well-Being

On September 26, 2017, the Consumer Financial Protection Bureau (“CFPB”) released the results of its first national survey regarding the financial well-being of both specific groups of U.S. consumers and the population as a whole.  Designed as a component of the CFPB’s strategy for improving consumer financial capability, the National Financial Well-Being Survey was conducted in 2016 by the CFPB using a 10-question survey which, based upon consumer responses, results in a score between 0 to 100, where a higher score indicates greater financial well-being.  In addition to measuring financial well-being, the survey collected other information related to:  (i) individual characteristics; (ii) household and family characteristics; (iii) income and employment characteristics; (iv) savings and safety nets; (v) financial experiences (e.g., whether a consumer has been denied credit, has used a non-bank short-term credit product, or has been contacted by a debt collector); and (vi) financial behaviors, skills, and attitudes.   Specific findings from the report include:

  • More than 40 percent of U.S. adults struggle to make ends meet.  Forty-three percent of the surveyed consumers reported difficulties in paying bills.  In addition, thirty-four percent of surveyed consumers indicated they had experienced a “material hardship” in the past year, including running out of food, not being able to afford medical care, or lacking money for housing.
  • Certain demographic and financial characteristics are correlated with financial well-being. Among the consumers surveyed, financial well-being was higher for older adults (aged 65 and older), who had an average score of 61, as compared to younger adults (aged 34 and younger), who had an average score of 51.  Moreover, educational attainment, employment status, and income correlated strongly with financial well-being.  However, other sociodemographic categories did not demonstrate the same relationship with financial well-being.  For instance, there was no demonstrable difference between the financial well-being of men and women.  Additionally, while there were some differences between financial well-being for various racial/ethnic groups, those differences were relatively small compared to the differences in subgroups based on educational attainment, employment status, and income.

In addition to releasing the results of the survey, the CFPB also released an interactive online tool to help consumers evaluate their own financial well-being.

Shortened T+2 Settlement Cycle for Securities Transactions is Implemented

On September 5, 2017, the securities industry implemented a shortened standard settlement cycle for securities transactions from three business days (“T+3”) to two business days (“T+2”). On March 22, 2017, the Securities and Exchange Commission (the “SEC”) had adopted an amendment to Rule 15c6-1(a) of the Securities and Exchange Act of 1934 that shortened the time period – from T+3 to T+2 – between the date of a contract for the purchase or sale of securities (other than certain exempt securities) and the date of payment of funds and delivery of the securities. As a result, under the new settlement cycle, if an issuer enters into a contract for the sale of common stock during the trading day on Monday, the transaction would settle on Wednesday.

The SEC adopted this amendment to (1) reduce the number of unsettled trades and the inherent market and liquidity risk in the settlement process and (2) increase the efficiency of capital market transactions.

Though the default rule is now T+2, parties to a contract for the purchase and sale of securities may expressly agree at the time of the transaction to a shorter or longer time period between the date of the contract and settlement.

Issuers, underwriters and their counsel should keep this new shortened standard settlement cycle in mind when drafting underwriting agreements and planning for closings as the parties are now operating under a condensed timeframe to prepare for, coordinate and execute closing with the issuer’s transfer agent and auditors. Our early experience is that issuers and underwriters are utilizing the shortened standard settlement cycle.

The CFPB Finalizes Amendments to ECOA Regulations and Seeks Public Comment on HMDA Policy Guidance

On September 20, 2017, the Consumer Financial Protection Agency (“CFPB”) announced final amendments to Regulation B, which implements the Equal Credit Opportunity Act (“ECOA”), to provide flexibility and clarity to mortgage lenders regarding the collection and retention of information about the ethnicity, sex, and race of certain mortgage applicants.  The CFPB also issued proposed policy guidance, with a request for public comment, regarding the loan-level Home Mortgage Disclosure Act (“HMDA”) data reported by financial institutions that the CFPB plans to disclose to the public beginning in 2019.

Regulation B Amendments

ECOA prohibits a creditor from discriminating against an applicant with respect to any aspect of a credit transaction on a prohibited basis, which includes, among other things, race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract).  To implement ECOA’s antidiscrimination principles, Regulation B generally prohibits a creditor from inquiring about the race, color, religion, national origin, or sex of an applicant or any other person (“applicant demographic information”) in connection with a credit transaction.

The amendments announced by the CFPB are designed to align Regulation B’s rules regarding the collection and reporting of applicant demographic information by mortgage lenders with the CFPB’s 2015 revisions to Regulation C, which implements HMDA and governs the collection, reporting, and disclosure of mortgage lending information, including HMDA’s separate requirement to collect and report applicant demographic information.  The revisions to Regulation C go into effect on January 1, 2018.

The amendments make three substantive changes to Regulation B:

  • Permitting additional flexibility in the collection of demographic information: Regulation B provides exceptions to the prohibition of creditor inquiries into applicant demographic information.  One such exception is that creditors that receive an application for certain dwelling-secured loans are required to collect and retain protected information, including race and ethnicity information.  This information is collected in terms of specified racial and ethnic categories that are broad and aggregated (e.g., Asian, Hispanic).   However, this aggregated racial and ethnic categorization is somewhat inconsistent with the revisions to Regulation C, pursuant to which creditors must permit applicants to self-identify their race and ethnicity using certain disaggregated racial and ethnic subcategories (e.g., Mexican, Puerto Rican, or Cuban under the aggregate category of Hispanic).  To remedy this inconsistency, the Regulation B amendments allow creditors to collect the applicant’s information using either the aggregate ethnicity and race categories or the disaggregated ethnicity and race categories and subcategories required by revised Regulation C.  In addition, to standardize the treatment of co-applicants under Regulation B and Regulation C, the amendments clarify that a creditor is permitted, but not required, to collect applicant demographic information from a second or additional co-applicant.

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UK Financial Conduct Authority Makes First Market Investigation Reference

On September 14, the UK’s Financial Conduct Authority (FCA) confirmed that it was making a Market Investigation Reference (MIR) to the Competition and Markets Authority (CMA) in relation to services for investment consultancy and fiduciary management.  This is the first time the FCA, which has significant numbers of competition lawyers within its ranks, has exercised its power to make a reference to the CMA.

Please see our client alert, in which we look at the background to the action and the scope of the MIR, and outline the potential industry impact on investment consultants and fiduciary management firms.

Federal Court Takes Expansive View of CFPB Statute of Limitations, Limits Restitution

On September 8, 2017, the U.S. District Court for the Northern District of California entered an order granting a civil penalty and injunctive relief in a CFPB case against mortgage loan servicer Nationwide Biweekly Administration, Inc. (“Nationwide”), its wholly-owned subsidiary Loan Payment Administration, and the principal of Nationwide. In its suit, the CFPB alleged that the defendants engaged in abusive and deceptive practices and violated the Telephone Sales Rule (“TSR”) in the course of offering its mortgage payment program.

Among the notable aspects of this case was the court’s interpretation of the relevant statute of limitations period. The Dodd-Frank Act generally sets a statute of limitations for the Bureau of “3 years after the date of discovery of the violation to which an action relates.” 12 U.S.C. § 5564(g)(1). Prior to this decision, no court had ruled on how to interpret the Dodd-Frank “date of discovery” provision.

Here, the court found that “mere receipt of a consumer complaint” does not cause the statute to run, and moreover that such an interpretation would be “unworkable.” Instead, the court wrote that even a “credible and specific” consumer complaint would “at most” provide “inquiry notice” and that the statute begins running only after the CFPB “actually” discovers facts allegedly constituting a violation of law or until a “reasonably diligent plaintiff would have” discovered those facts. In other words, the clock does not begin to run until the Bureau has had enough time to conduct a preliminary investigation into the wrongdoing alleged in a consumer complaint.

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Federal Court Dismisses Part of CFPB’s Case Against TCF National Bank

On September 8, 2017, the U.S. District Court for the District of Minnesota entered an order granting in part and denying in part a motion to dismiss claims brought by the CFPB against TCF National Bank (“TCF”) for alleged wrongdoing in connection with offering overdraft services.

Brought in January, the case centered on allegations that TCF, in the course of obtaining customer consent for enrollment in overdraft protection services, violated opt-in and disclosure requirements under Regulation E and engaged in abusive and deceptive practices in violation of Dodd-Frank’s UDAAP provisions.

The court dismissed the CFPB’s Regulation E claims relating to the overdraft notice and opt-in requirements, finding that TCF had complied with the regulation’s specific, “surgical” requirements. The court also dismissed the CFPB’s UDAAP claims insofar as they related to conduct predating the agency’s effective date of July 21, 2011. The Bureau made only a cursory attempt to justify including conduct prior to July 21, 2011. The court understood the pre–July 21, 2011, allegations as based on a continuing-violation theory that, if upheld, would sweep in all prior practices simply because there was some violation after the effective date.

Notably, despite the bank’s technical compliance with the Regulation E overdraft notice and opt-in requirements, the court found that the Bureau had stated a claim against TCF for abusive and deceptive conduct after July 21, 2011, in relation to its opt-in practices. The ruling demonstrates that strict compliance with detailed regulations governing particular activities, such as the Regulation E overdraft notice and opt-in requirements, may still run afoul of Dodd-Frank’s amorphous, blanket UDAAP prohibition.

CFPB Issues its First No-Action Letter

On September 14, 2017, the Consumer Financial Protection Bureau (the “CFPB” or the “Bureau”) issued a no-action letter for the first time, after having finalized its no-action letter policy in February 2016.  The Bureau’s letter grants a request by Upstart Network, Inc. (“Upstart”), an online lender that uses both traditional and non-traditional credit scoring data, regarding the application of the Equal Credit Opportunity Act and Regulation B to Upstart’s automated model for underwriting applicants for unsecured non-revolving credit.  In its press release accompanying the letter, the Bureau explicitly referenced its ongoing interest in learning more about the benefits and risks of using alternative data in credit scoring, an issue the Bureau raised in February 2017.

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