Guest post by Richard P. Eckman, Gregory J. Nowak, Esuga T. Abaya, and Ashleigh K. Reibach – Pepper Hamilton LLP
On July 16, 2015, the U.S. Department of the Treasury (the Treasury) issued a notice and request (the Request) for public information concerning the role of marketplace lending in the financial services industry. Treas. Notice 138 (July 20, 2015). Marketplace lenders, or “peer-to-peer lenders” as they are often referred to, are online platforms that match investors with borrowers. Some platforms cater to small business borrowers, others focus on consumer lending, and others focus on real estate lending, receivables factoring, student loan origination and much more. The marketplace lending industry originated $12 billion in loans of various types in 2014, two platforms have gone public, and several securitizations of these loans have been packaged and sold. Yet, the industry has remained largely ignored by policymakers and regulators on any systemic basis — until now. In the consumer area, there are a host of federal laws that apply to loans made to consumers, and many states also act to protect borrowers, regardless of who the lender is. Nevertheless, the state-by-state patchwork of laws and regulations, and the application of securities and banking laws designed for other purposes and generally applicable here, have caused slower evolution of this marketplace than would otherwise have been possible had the “rules” been more carefully and robustly designed.
The Treasury’s request bears the hallmark of a preliminary, information-gathering inquiry. The Treasury posed 14 detailed questions to market participants regarding the following:
1. the different models used by marketplace lenders and how these models may raise different regulatory concerns
2. the role electronic data plays in marketplace lending and the risks associated with the use of electronic data
3. how marketplace lenders tailor their business models to meet the needs of diverse consumers
4. whether marketplace lending expands access to credit to underserved markets
5. marketing techniques utilized by marketplace lenders
6. the process used by marketplace lenders to analyze the creditworthiness of borrowers
7. the relationship between marketplace lenders and traditional depository institutions
8. the processes marketplace lenders use to manage certain client operations, including loan servicing, fraud prevention and collections
9. the role the government could play in effecting positive change in the marketplace lending industry
10. whether marketplace lenders should be subject to risk retention rules
11. the harms that marketplace lending may pose to consumers
12. factors that investors should consider when making investment decisions
13. the secondary market for loan assets originated in the peer-to-peer marketplace
14. whether there are other key issues that policymakers should monitor.
The Treasury Request specifically excluded from its inquiry comments relating to higher cost consumer loans that are the subject of a soon-to-be-issued proposed regulation relating to small-dollar loans with interest rates exceeding 36 percent by the Consumer Financial Protection Bureau (CFPB). Comments on the Request will be accepted by the Treasury until August 31, 2015.
The Request has a generally positive tone and discusses the role that marketplace lenders have played to date in providing access to credit to small businesses and consumers who, in many cases, have faced barriers in accessing credit. Marketplace lenders are able to deliver credit at a lower cost, in a more expedited fashion, and to a more diverse group of borrowers than traditional banks. One question posed by the Treasury asks how marketplace lenders can continue to meet the needs of consumers who are part of traditionally underserved markets.
Some of the questions posed, however, reflect a complete misunderstanding of how marketplace lenders operate. Loans facilitated by marketplace lenders, which often use third-party banks to originate loans to consumers, are subject to the full panoply of federal and state consumer financial protection laws because they are typically originated by regulated financial institutions. In addition, investors in marketplace loans typically are investing insecurities, thereby providing them with the protection of the U.S. securities laws relating to disclosure and fraud. And, some new industry investors are investing in marketplace loans through investment funds designed for these purposes, which funds are subject to regulation by both the Securities and Exchange Commission and the states.
Of some concern is the reference to how the government could help foster the marketplace lending industry. Governmental intervention in this space at this time could have the impact of increasing costs and compliance risks and restricting innovation. To date, Congress and the Obama administration have let marketplace lenders develop in a free-market manner. Nevertheless, even the hardiest freemarket advocates recognize the need for governing principles and adherence to basic ethical standards, but the questions concerning “risk retention,” and their ilk, suggest that the requestors are thinking of these platforms as if they were banks, which they most certainly are not. There is no “promise” of the return of invested capital (as there is in a bank) nor a promise of any specific return (returns are a function of the underlying investments’ performance only — in that respect they are truly “peer-to-peer”).
The reference to requiring lenders to have “skin in the game” clearly could increase the costs of doing business in this space and needs to be justified from a policy standpoint. As a nascent industry, it occupies a minuscule portion of both the small business and consumer lending marketplace, and any suggestion of requiring a portion of a loan from a risk standpoint seems premature.
The Treasury’s Request will likely foster a discussion of the merits of government regulation of the marketplace lending industry. The best interests of the marketplace lending industry, which has few dominant players and no trade association, would be best served by thoughtful interaction with Treasury officials to bring them up to speed on how the industry has policed itself and developed within the current regulatory confines of banking, broker-dealer, investment fund, investment advisory and securities laws, and delineation of what issues need to be addressed to bring about clarity and, therefore, efficiency in the marketplace. There is some movement in this regard, as we await the results of the recent Capitol Hill pressure on the CFPB to promulgate regulations that will implement section 1071 of the Dodd-Frank Act. These regulations will impose reporting requirements with respect to the types of persons receiving small business loans similar to the reporting requirement that mortgage lenders are subject to under the Home Mortgage Disclosure Act.
Pepper Hamilton LLP will be preparing comments to the Treasury. If you have any comments that you would like us to consider for our submission, please contact Rick Eckman at 302.777.6560, email@example.com, or Greg Nowak at 215.981.4893, firstname.lastname@example.org.
Richard P. Eckman, Partner, email@example.com
Richard P. Eckman is a partner in the Wilmington office of Pepper Hamilton LLP. He is a finance and transactional lawyer and from 2003 to 2015 was chairman of the firm’s Financial Services Practice Group, which includes over 40 lawyers practicing in the areas of investment management, commercial and consumer financial services, public finance and affordable housing.
Mr. Eckman’s transactional practice focuses on representing financial institutions, corporations and other entities in complex financing transactions, including mergers and acquisitions, asset securitizations and other lending and venture transactions.
Gregory J. Nowak, Partner, firstname.lastname@example.org
Gregory J. Nowak is a partner in the Philadelphia office of Pepper Hamilton LLP and a practice leader for hedge funds in the firm’s Funds Services Practice Group. He concentrates his practice in securities law, particularly in representing investment management companies and other clients on matters arising under the Investment Company Act of 1940and the related Investment Advisers Act of 1940. Mr. Nowak also handles mergers and acquisitions, corporate and regulated investment company tax work and other corporate matters. He also represents broker-dealers and CTAs and CPOs with respect to matters under the Securities Exchange Act of 1934 and the Commodity Exchange Act.
Esuga T. Abaya, Associate, email@example.com
Esuga T. Abaya is an associate with Pepper Hamilton LLP, resident in the Philadelphia office. He is a member of the firm’s Corporate and Securities Practice Group, with experience in a variety of transactions and corporate finance matters, including experience in the peer-to-peer lending space.
Ashleigh K. Reibach, Associate, firstname.lastname@example.org
Ashleigh K. Reibach is an associate in the Financial Services Practice Group of Pepper Hamilton LLP, resident in the Wilmington office. Ms. Reibach concentrates her practice on commercial lending transactions and banking, regulatory and consumer financial services.
Pepper Hamilton LLP
Pepper Hamilton LLP (www.pepperlaw.com) is a multi-practice law firm with more than 500 lawyers nationally. The firm provides corporate, litigation and regulatory legal services to leading businesses, governmental entities, nonprofit organizations and individuals throughout the nation and the world.
The firm’s Marketplace Lending practice represents clients worldwide in all segments of the industry – platforms, investors, service providers, and even banks – to help them identify the legal issues that arise from their chosen approach to the market. Our clients cover the spectrum of emerging ideas, including FinTech start-ups, seasoned businesses and institutional and non- institutional regional and global investors. We tailor legal solutions to their specific business objectives, risk tolerances and market constraints.
Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Pepper Hamilton LLP. This work reflects the law at the time of writing in July 2015.