At least six federal agencies, including the U.S. Department of Justice (DOJ), the Consumer Protection Financial Bureau (CFPB), and the Federal Trade Commission (FTC), are currently coordinating a broad crackdown of the online payday lending industry. The agencies are trying to shut down companies that offer short-term loans online at very high interest rates.
The online payday lending industry is rapidly growing. Online payday lending volume rose by 10 percent to $18.6 billion in 2012. Online payday loans now account for nearly 40 percent of the payday lending industry.
The Department of Justice has issued civil subpoenas to more than 50 financial companies, including banks and payment processors, that connect borrowers with online lenders. Federal agencies are also pressuring banks to cut ties with online lenders to prevent the lenders from being able to access consumers’ bank accounts. The scope of the investigation shows that the crackdown is focused not just on the individual lenders, but also the infrastructure that supports the lenders.
Multiple state agencies are also involved in investigations of the online payday lending industry. State regulators have brought actions against online payday loan companies under various laws, such as usury laws that limit the amount of loans that can be provided to borrowers or cap the interest rates for the loans.
Earlier this month, New York State’s top financial regulator ordered 35 online payday lenders to stop offering loans that were in violation of the state’s usury laws and urged more than 100 banks to cut off access to the online payday lenders. At least nine states, including California, Colorado, Minnesota, Oregon and Virginia have also all taken action against individual online payday loan companies in the past year.
On August 12, 2013, the New York Attorney General’s Office sued Western Sky Financial, an online lender, and its affiliates alleging that they charged interest rates that were 10 times higher than rates allowed under the state usury law. Western Sky Financial operates on the land of the Cheyenne River Sioux Reservation in South Dakota and has already been the target of actions by regulators in Colorado, Oregon and Minnesota. Indian tribes are a major player in the online payday loan industry, with lenders forming partnerships and operating on tribal lands. Lenders have argued that they are part of a sovereign nation and not subject to federal or state laws.
Last year the FTC sued several companies for their payday loan practices, but some of the defendants sought to have their case dismissed, claiming that their affiliation with an American Indian tribe made them immune from those federal statutes. Last month a federal magistrate judge ruled that the FTC has authority over payday lending companies, regardless of their tribal affiliations, and that all companies are subject to regulation under the Federal Trade Commission Act, the Truth in Lending Act, and the Electronic Fund Transfer Act.
The online payday lending industry is attracting increasing scrutiny from both federal and state regulatory agencies, and more enforcement actions are very likely to come soon. Online payday lenders need to be sure that they are complying with all federal and state laws to avoid being in the government’s crosshairs.
On May 28, 2013, federal prosecutors unsealed an indictment charging seven men with allegedly operating an organization known as “Liberty Reserve,” which prosecutors allege was established for the sole purpose of creating an illegal digital currency that could be used to launder money. This is a case that anyone involved in businesses that rely in any way on bitcoins will definitely want to watch.
Prosecutors say that Liberty Reserve was used to aid in identity theft, computer hacking, and other illegal activities. The indictment alleged that Liberty Reserve was responsible for laundering more than $6 billion over the last seven years through 55 million transactions. The company allegedly has about one million users across the globe, including 200,000 in the United States.
The indictment comes just a few months after the Financial Crimes Enforcement Network (FinCEN), a branch of the United States Department of the Treasury, issued new guidelines stating that virtual currency exchanges should follow traditional money laundering rules. Virtual currencies, such as the well-known bitcoin, account for only a small percentage of global financial transactions, but their popularity is growing rapidly.
Like bitcoin, Liberty Reserve operated as a virtual currency exchange; however, there are some key differences between bitcoin exchanges and Liberty Reserve. Bitcoin transactions operate in a more transparent way than transactions on Liberty Reserve did. Bitcoin transactions are stored in a public ledger called a “block chain” to keep people from writing the equivalent of a bad check with bitcoins. It is that same public block chain that makes it possible to trace transactions years after they have occurred.
Earlier this month, federal authorities cracked down on Mt. Gox, the world’s largest bitcoin exchange. The basis of the crackdown on Mt. Gox was a failure to properly register as a money transmitter. There were no allegations by law enforcement that bitcoin currency itself violated state or federal law. Indeed, the Treasury Department regulations reflect that such currency is lawful, but subject to regulation.
This month’s actions by federal authorities against Mt. Gox and Liberty Reserve clearly show that law enforcement is monitoring virtual currency exchanges. Although there is no immediate reason to believe that a properly registered bitcoin exchange violates state or federal law, those companies operating virtual currency or bitcoin exchanges should be aware that law enforcement is following this trend and capable of quickly reacting to perceived violations of the law.
We have written previously about Bitcoin, the new form of “peer-to-peer” currency whose proponents expect to be a game-changer in the world financial markets. It’s not clear yet what Bitcoin’s ultimate destination will be, as the currency has had a lot of scrutiny, and undergone a tremendous amount of volatility, lately.
In a recent 24-hour period, the value of a single Bitcoin on the largest Bitcoin exchange, Mt. Gox, was high as $266 and as low as $105. It’s hard to sustain a business model with that incredibly high volatility factor.
However, according to TechCrunch, angel investors and venture capitalists remain “hungry to invest in the ecosystem surrounding the decentralized digital currency.” In other words, investors want to create a different, and possibly superior, Bitcoin.
That currency is known as OpenCoin, which wants to create a decentralized global currency yet prefers to stay away from the moniker of “another Bitcoin.” The company behind OpenCoin has raised an undisclosed amount of venture-capital money to expand the open-source code behind Ripple, which is a virtual currency and payment system that aims to make it easy and affordable for anyone to trade any amount in any currency.
OpenCoin hopes to clear its transactions within minutes; to handle dollars, euros, and other currencies seamlessly; and to solve BitCoin’s security issues.
Some observers think OpenCoin has a greater chance of success than Bitcoin because it has been carefully conceived rather than just springing up from the minds of a few hackers, and because it doesn’t have a history of volatility and of facilitating illegal payments.
But it’s still a very long way before any of these artificial currencies catches on. We will be watching them carefully. We hope that financial regulators, both in the United States and world-wide, realize that these currencies can do a great deal of good, and that the Treasury Department doesn’t conclude that they are nothing more than vehicles for money laundering. Treasury’s recent announcement that dealers in Bitcoin-like currencies must obey money-laundering laws seems like an acceptably moderate approach.
Last December, we wrote about the U. S. Securities and Exchange Commission’s issuance of so-called “Wells” notices indicating that the agency was considering whether to bring enforcement proceedings against Netflix and its CEO, Reed Hastings. The SEC’s ire was aroused by a posting by Hastings on his personal Facebook page about Netflix’s success. The agency was concerned about whether such statements in social media complied with disclosure requirements known as “Regulation Fair Disclosure” or “Reg FD.”
In general, Reg FD requires that, when an issuer discloses material, nonpublic information to certain individuals or entities – generally, securities market professionals such as stock analysts or holders of the issuer’s securities who may well trade on the basis of the information – the issuer must make public disclosure of that information. The purpose of these restrictions is to prevent issuer companies from disclosing material information preferentially to certain traders or securities market professionals.
On April 2, 2013, the SEC issued a report that made clear that companies that use social media outlets like Facebook and Twitter to announce key information are in compliance with Reg FD so long as investors have been alerted about which social media will be used to disseminate such information. In approving the use of social media (with the stated proviso), the SEC reinforced that Reg FD applies to the use of what it characterized as “emerging means of communication” the same way that it applies to company websites, and referenced the SEC’s 2008 guidance regarding the use of websites.
The SEC’s conclusion should be no surprise. On the one hand, it reinforces the widely recognized and increasing use of social media as a source of information by a growing segment of the population. On the other hand, it serves as a reminder to companies that they need to make sure that all investors know and have access to the channels that the companies use to issue important information.
The likelihood, for now, is that companies will continue to use a variety of means to issue information to the public – including social media, websites and more old-school methods such as press releases. But the acceptance of social media as an appropriate means of disclosure for publicly owned companies is an important step forward in the evolution of social media from a means of friendly banter to an important information channel for businesses and investors alike.
The problematic practice of robosigning – whereby banks and other lenders improperly foreclosed on properties through formulaically processing foreclosure documents – has been much in the news over the past couple of years. The feds have been investigating banks and individuals; state attorneys general have joined forces in pursuit of robosigners; and, unsurprisingly, there have been a number of class actions filed by consumers whose homes were foreclosed.
The fallout of these actions has been somewhat inconsistent. On the settlement side, banks and individuals are facing hefty penalties: Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, and Ally entered into a massive $25 billion settlement with the Justice Department and state attorneys general (of 49 states) in early 2012. The mortgage servicing firm, Lender Processing Services (LPS), recently entered into a $120 million settlement with a coalition of state attorneys general (of 45 states). A founder of one of LPS’s subsidiaries, Lorraine Brown, pleaded guilty to federal conspiracy charges and Missouri state charges and faces not less than two years imprisonment.
Those defendants who have not settled may be faring better. In early March, a Nevada district judge threw out an entire case against two title officers of LPS who faced more than 100 felony counts. (The judge’s ruling was not merits-based but rather based upon prosecutorial misconduct.) A New Jersey federal judge recently dismissed a putative class action against Bank of America, noting the plaintiff’s failure to prove that robosigning constituted fraud.
Part of the challenge for cases that don’t settle out may be proving damages to homeowners who lost their homes: If a home was foreclosed on deadbeats, where are the damages in rapid-fire paper pushing? Some banking experts have found that, between 2009-2012, mortgage servicers created some 800,000 foreclosures that could have been avoided through loan modification programs. And foreclosure practices at BofA and Morgan Stanley subsidiaries were found to have violated the Servicemembers Civil Relief Act, which provides active servicemembers financial protection in matters such as civil proceedings, income tax disputes and foreclosures. But these two categories are only a small subset of foreclosures, which have amounted to between one million and four million each year for the last six years.
One lesson from these matters may be that settling is not always the best option. But another take-away that hasn’t come up is how banks and mortgage servicers got into the practice of robosigning in the first place. The issue faced by the banks and lenders was a glut of foreclosures and a related mountain of paperwork to process those foreclosures. How could they effectively address the problem and the dead weight on their ledgers? The answer was to institute an efficient, and automated, process. The problem with automation, though, is a lack of oversight or subjective inquiry – the very purpose behind much of the required foreclosure documents.
While the banks and processors are certainly to blame for false certifications and notarizations, their actions are not as nefarious as many make them out to be. How often are we all guilty of “robosigning” the terms and conditions for a new software program or credit card application? How often do we read all the new disclosures that financial institutions are required to send with each statement or loan request? Part of the problem is that we are faced with a mass of disclosures resulting from both regulation and excess litigation. The information overload is part of what has played out in the robosigning scandal.
The Government Accountability Office just released a report criticizing the Federal Reserve’s review of the robosigning matter, saying that the review itself has become cumbersome and inconsistent. The only problem is that there is no realistic resolution to the problem. Until we can devise a way to be both thorough and totally efficient in processing information, we will inevitably face new versions of the robosigning scandal.
Timothy Lee at Forbes magazine has reported today that the Financial Crimes Enforcement Network (FinCEN), a branch of the Treasury Department, has issued new guidelines on the legal status of Bitcoin under U.S. money laundering laws. Essentially, Bitcoin dealers have now been placed under the nation’s anti-money laundering regulations and must comply with those rules.
Lee notes that Bitcoin exchanges, which exchange Bitcoins for conventional currencies, and most Bitcoin “miners,” which process Bitcoin transactions, must now register as Money Services Businesses (MSBs) under the Treasury regulations. Ordinary users of Bitcoins need not register.
Bitcoin is a peer-to-peer network that exchanges the virtual currency in a largely unregulated environment. Lately, Bitcoins have become acceptable for a number of types of transactions, and some see them as a currency of the future that transcends national borders.
Lee argues that the Treasury action is actually not a bad thing for Bitcoin’s future.
“FinCEN is clearly trying, in its somewhat bumbling way, to squeeze a square technological peg into its round regulatory hole. Reading between the lines, FinCEN is saying that if Bitcoin-based businesses fill out some paperwork and collect some information about their customers, then they’ll be left alone,” Lee writes.
Given the existence of U.S. anti-money-laundering statutes, Lee adds, “FinCEN’s guidance is probably the best Bitcoin fans could have hoped for: it sends a clear sign that America’s anti-money laundering regulators do not consider the currency a threat and isn’t going to try to force it to change or shut down.”
We tend to agree. There needs to be a balance between enforcing the money-laundering laws (which are designed as a tool against terrorism and other serious wrongdoing) and permitting the free exchange of commodities and currency. It appears that the Administration, so far, is striking the correct balance.
Bitcoin – it sounds like a token you might use to play skeeball at a beachside arcade. It is actually a relatively new, virtual online “currency” being used for payments across the Internet. While some observers have noted that the Bitcoin has been utilized primarily for purchases in the Internet “underworld,” the Bitcoin actually has gained traction more recently as a legitimate payment exchange. The Bitcoin might just be the surprise of the next generation of e-commerce and its progeny, mobile commerce.
The Bitcoin originated in 2009 with the issuance of the first Bitcoins by Satoshi Nakamoto, the pseudonymous person or group of people who designed the original protocol and created the peer-to-peer network. Users connect with other users rather than with a central issuer or server. This makes the Bitcoin attractive for illegal activities – authorities can’t pounce on a central office or simply seize one organization’s assets. The Bitcoin has no central issuing bank. Prices fluctuate a great deal; this past summer one Bitcoin traded at around $10. It is estimated that the monetary base of the Bitcoin is around $110 million.
There are several advantages to Bitcoins. They are largely unregulated. Also, payments can be made anonymously, leaving a minimal or no paper trail. Unlike credit cards, merchants do not face the hassle and uncertainty of “charge backs.” However, because of its past “underground” use, the Bitcoin lacks a reputation and general acceptance by mainstream merchants. For instance, the website “Silk Road” allowed users to buy and sell heroin and other illegal drugs provided they paid for their purchases using Bitcoins. Online gambling services have utilized Bitcoins with relative success.
While the past use of the Bitcoin has been limited, the new currency is picking up steam. Just a few days ago, BitPay, a payment solutions company, announced a large investment by a group of well-known tech investors. They see the Bitcoin as the next “PayPal” offering a fast payment method without the exchange of sensitive personal information that goes along with traditional credit card payments. Investors also see the benefits for small businesses, which can much more easily take payments from overseas using Bitcoins. Today, we can use Bitcoins to buy a wide array of products and services. This website provides links where we can purchase, for instance, jewelry, electronic cigarettes, natural cosmetics, and even survival products and dry cleaning, just to name a few offerings.
Just last month, the Bitcoin gained further acceptance when the Bitcoin-Central exchange owned by Paymium announced that it is partnering with registered PSP Aqoba and Frank Bank Credit Mutuel Arkea in order to legally hold balances in payment accounts within the European regulatory framework. However, as Bitcoins have not to date been backed by a governmental entity and several users have reported losses from fraud and hacking into their computers where they stored Bitcoins, continued use and acceptance will be affected by the reliability of the payment network, as well as any attempts to regulate it.
As use of the Bitcoin expands, regulators (particularly in the United States) may seek to regulate the currency. U.S. prosecutors tend to view anonymous payments with skepticism and suspicion.
Our view is that use of the Bitcoin network has expanded in large part as a natural reaction to overly zealous authorities enforcing anti-money laundering rules and policies against banks and individuals. Parties facing onerous reporting obligations and over-the-top fines have been seeking alternative payment methods. The FBI has shown some interest in Bitcoin (in an April 2012 report the FBI expressed concern about cyber criminals using Bitcoins). Last year, a spokesman for FinCEN stated that “The anonymous transfer of significant wealth is obviously a money-laundering risk, and at some level we are aware of Bitcoin and other similar operations, and we are studying the mechanism behind Bitcoin.”
However, we think the law will take some significant time to catch up with the fast-moving network. It remains to be seen whether current U.S. law can be applied to cover Bitcoins, or if specific legislation would be needed. Further, even if U.S. authorities seek to regulate Bitcoins, actual enforcement would be difficult as there are no stationary “assets” to be seized (not even a domain name or website). Bitcoins are typically stored in a “wallet” on a user’s computer. Authorities would in many instances be required to pursue each “peer” in the peer to peer network, which does not seem terribly practicable. In the interim, Bitcoins appear to be growing in use across industries and geographic locations.
People these days use Facebook to tell their “friends” about all kinds of things – a favorite TV show, a political bent, a new relationship and all kinds of other details about their lives. But recent enforcement action by the U.S. Securities and Exchange Commission should make clear to corporate officers and boards that Facebook may not be the best place to talk about company operations.
Netflix and its Chief Executive Officer, Reed Hastings, both received so-called “Wells” Notices from the SEC last week arising from Facebook postings that Hastings made in June about the company’s success. An SEC Wells notice notifies a company or individual that the agency intends to recommend enforcement action and invites the company or individual to submit an explanation to the SEC why it should not proceed.
In July, Hastings wrote on his Facebook page that Netflix users streamed more than 1 billion hours of video in June. The SEC is questioning whether that disclosure – access to which would be limited to those who are “friended” with Hastings on Facebook — violated fair disclosure regulations known as “Reg FD”. Reg FD states that, when an issuer discloses material, nonpublic information to certain individuals or entities – generally, securities market professionals such as stock analysts or holders of the issuer’s securities who may well trade on the basis of the information – the issuer must make public disclosure of that information. The purpose of these restrictions is to prevent issuer companies from disclosing material information preferentially to certain traders or securities market professionals.
Over the years, the SEC has periodically issued guidance about how Reg FD should be applied to developing technologies – first in the context of websites and then in the context of blogs. It does not appear, however, that the agency has previously issued formal guidance for the use of other forms of social media such as Facebook. The general requirements for the use of such technologies in compliance with Reg FD is that the information must be published through a “recognized channel” of distribution, and it must be disseminated in a manner designed to reach the public in general.
In public statements, Netflix and Hastings note the large number of people with access to the Facebook post (which they set at 200,000) included a number of reporters and bloggers, and argue that the size and composition of this audience make the Facebook posts fully compliant. They noted that many people re-posted the post (making it available to an even broader audience) and that there was press coverage thereafter as well. They have also asserted that the fact disclosed was not “material” to investors, noting that there had been a previous statement on Netflix’s blog as few weeks earlier that they were serving nearly 1 billion hours per month. While the value of Netflix stock did rise on the day of the Facebook post, Netflix and Hastings note that the increase started well before that mid-morning post, and assert that it was likely due to a positive Citigroup research report issued the previous evening.
It very well may be that the SEC accepts the explanation proffered by Netflix and Hastings and decides not to proceed with its civil enforcement action. Nevertheless, the story is a good object lesson for corporate personnel regarding the care that must be taken with statements in social media, and perhaps a sign of how government regulators are beginning to scrutinize social media as a new forum in which they may find violations of the regulations under their purview. To the extent that the SEC anticipates policing Facebook or other social media as part of its regulatory oversight of information disclosure, the agency should, in fairness, make clear to issuers the parameters of acceptable statements in those fora.
Three states have joined a lawsuit to challenge the constitutionality of the Financial Stability Oversight Council (FSOC), a Dodd-Frank-created regulatory body headed by the Treasury secretary. The panel, composed of top financial regulators, is charged with overseeing broad threats to the financial system, and has the power to liquidate failing non-bank financial institutions it views as a threat to the that system. The attorneys general of Michigan, Oklahoma, and South Carolina are challenging the legality of the FSOC, arguing that the panel is too powerful and should be subject to additional checks and balances.
The states are bringing their claim as a subset of a larger suit filed by the Competitive Enterprise Institute, a conservative think tank that is also challenging the constitutionality of the power granted to the Consumer Financial Protection Bureau (CFPB). The states do not join the challenge to the CFPB but makes claims only against the FSOC. The state attorneys general argue that the FSOC’s liquidation power creates “death panels for American companies” with little outside oversight.
However, the AGs’ argument overlooks both the substance of the provision and the background against it was implemented. Far from lacking oversight, the FSOC must undergo a multi-level, multi-branch review in order to liquidate a financial institution. In order to initiate liquidation proceedings, first there must be a written recommendation for the Treasury Secretary to appoint the FDIC as a receiver for the failing company. The recommendation must contain a host of information including an evaluation of the likelihood of a private-sector alternative to prevent default. Then there must be a two-thirds vote of the Fed Board of Governors and a two-thirds vote of the FDIC or SEC, or the affirmative approval of the Director of the Office of Federal Insurance in order to appoint a receiver.
If the company does not consent to the appointment of the FDIC as a receiver, the matter goes to U.S. District Court for the District of Columbia, where a judge may strike the receivership if it determines that the secretary’s decision was arbitrary and capricious. Finally, the Government Accountability Office must review and report to Congress on any receivership appointment.
This liquidation power is not entirely new. For decades, the FDIC has had the ability to take over failing federally insured banks. The difference is that this new provision extends to non-bank financial companies. This provision was enacted in direct response to the recent financial crisis, in which the federal government had to step in to save financial institutions whose risky investments threatened to collapse the American economy. The role of the FSOC is to eliminate the expectation that the U.S. government will shield the institutions from losses in the event of a future failure, while simultaneously ensuring an orderly liquidation for failed companies.
At this time, the FSOC has not taken action to liquidate any financial institutions. It has, however, designated a number of nonbank financial institutions as “Systematically Important Financial Institutions” (SIFI). Institutions designated as SIFI are subject to more stringent oversight, including stress tests, higher capital levels and tougher liquidity requirements.
The FSOC began making SIFI designations in July of this year, with the fairly uncontroversial designation of eight financial market utilities. On Monday the FSOC announced that it is considering a number of additional non-banks for SIFI designation. AIG has confirmed that it is one of the institutions under consideration, a development that the company said it both expected and welcomes. Other non-banks rumored to be under consideration as SIFIs include MetLife, Prudential, and General Electric.
It appears that the state AG’s are contesting the FSOC’s liquidity authority out of fear that it gives too much power to federal regulators. However, history has shown how economically dangerous it is for financial institutions to be left to their own devices with little oversight or accountability. The FSOC’s powers are constitutional and within the bounds of the law. The states’ challenge should not survive judicial scrutiny, and the FSOC’s liquidation power should be upheld.