A recent legal conference in Washington, DC, highlighted newly proposed and ongoing regulatory changes in California concerning consumer and commercial lending. In short, one of the conference’s messages was that lending enforcement is increasing and the California Department of Business Oversight (DBO) is becoming much more aggressive in its enforcement posture (including with respect to treating retail installment sales contracts and merchant cash-advance products as loans).
The DBO Commissioner, Manuel Alvarez, was installed last spring and is a former Consumer Financial Protection Bureau (CFPB) enforcement attorney. He has already made some noticeable changes in the DBO’s enforcement posture, and we expect to see more enforcement actions brought in the months and years to come under his leadership.
As we previously reported, California Governor Gavin Newsom submitted his $222 billion budget proposal for the 2020-2021 fiscal year on January 10. Among other priorities identified, the budget earmarks tens of millions of dollars for the creation and administration of the California Consumer Protection Law (CCPL). The governor’s budget proposal specifically notes the need for this expanded consumer protection law as arising from “[t]he federal government’s rollback of the CFPB [which] leaves Californians vulnerable to predatory businesses and leaves companies without the clarity they need to innovate.”
Under the proposal, the DBO would dramatically expand its consumer protection role to define the contours of, and to administer, the CCPL. Should California’s lawmakers adopt this proposal, which seems all but certain, even with some modifications, the DBO would be renamed the Department of Financial Protection and Innovation (DFPI), and the agency would have materially more budgetary resources and lawyers to pursue enforcement actions (the proposal provides the new agency with enforcement authority relating to some 51 state laws as well as certain federal consumer financial services laws).
In addition, California’s still not-yet-finalized commercial financing disclosures proposal continues to present significant compliance concerns and issues for industry. Commissioner Alvarez expects a final rule to be issued late this year or early next year, but it is not yet clear how long industry will have to come in compliance. Additionally, significant concerns remain regarding the substance of the proposed disclosures, since many of them would be difficult if not impossible to apply to various commercial credit products. Industry appears to be already contemplating the use of assumptions in the disclosures, which presents its own set of issues and challenges.
For example, it is quite challenging to disclose the total dollar cost of financing and the total cost of financing expressed as an annualized rate (two of the proposed disclosures) at the time that a specific offer of commercial financing is extended for accounts receivable purchase transactions or factoring products; these financing arrangements typically contain variable cash flows and the total sum of those are not known until the financing has been paid in full. In turn, a commercial lender may have to be creative and assume a standard set amount of transactions from the borrower every month, which may be a reasonable estimate but could also be subject to the ebb and flow of business revenues, sales, and cash flow cycles.
Finally, we note that California has also taken a very negative view of bank-fintech partnerships. Commissioner Alvarez and certain state legislators recently issued public warnings to fintech companies seeking to pursue bank partnerships in order to lend to California residents without having to comply with California’s new interest rate-cap law, since depository institutions generally have the legal ability to apply their home states’ interest rate rules across the country. California appears to be taking the position that: (i) California courts and regulators are likely to enforce the new rate caps; (ii) California’s consumers deserve the protections afforded by the new rate-cap law; and (iii) companies that respect the rate caps deserve a level playing field.
Because California is the fifth largest economy in the world, California law is effectively US law for purposes of anything that touches the online world, including fintech. Ultimately, these efforts favor the large platforms over smaller fintechs because compliance is often straightforward, just costly. In turn, enhanced regulation and enforcement in California may work to the disadvantage of new entrants and may also encourage others to leave the state.