Regulatory risks in marketplace lending

November 15, 2016

Report reviewMarketplace lending has dominated much of the financial press in recent years, as its extraordinary growth has attracted both investment capital and regulatory attention. As marketplace lending becomes more commonplace and occupies larger part of the overall loan market, it will become essential for marketplace lenders and consumer financial services practitioners to familiarize themselves with the unique regulatory issues facing this fast-growing industry.

In a recent Expert Analysis article in Consumer Financial Services Law Report, Scott Pearson and Taylor Steinbacher of Ballard Spahr LLP discussed the marked increase in regulatory interest surrounding marketplace lending by state and federal regulators.

(Westlaw users: Click here for the article, and here for the latest from Consumer Financial Services Law Report.)

They also touched on various regulatory and legal issues which pose a threat to marketplace lending business models, such as the Madden and “true lender” issues, and offered theior views on state licensing issues.

As Pearson and Steinbacher explain, the issues facing marketplace lenders depend on the type of products they offer, who those products are offered to, and how their business is structured. Marketplace lenders that act as marketing and servicing agents for banks and do not originate loans themselves face the most prominent regulatory challenges. These include a couple of issues that affect a marketplace lender’s ability export interest rates of their partner banks.

Fist is the issue that arises from the 2d U.S. Circuit Court of Appeals recent decision in Madden v. Midland Funding, 2015 WL 2435657, which suggests that when a non-bank purchases a loan made by a national bank, the bank’s ability to charge interest at the bank’s exported rate does not follow the loan. This obviously presents serious challenges to marketplace lenders using the bank partner model.

The “true lender” issue, which has been raised by private plaintiffs recently, attacks the bank partnership model by arguing that the bank originating the loan is not the “true lender,” and that the partnership with the bank is simply a sham calculated to avoid state usury laws. Proliferation of both the Madden and “true lender” issues have caused marketplace lenders to restructure their bank partnership models in various ways to avoid these risks.

Separate from these two significant issues are actions taken by state licensing authorities to require licensure by marketplace lenders, or to prohibit existing licensees from participating in transactions which would be prohibited by state usury laws.

A notable example of this is the CashCall Inc. v. Maryland Commissioner of Financial Regulation case in which a Maryland regulator succeeded in arguing that online lender that purchased loans made by an out-of-state bank required a license to service those loans within the state.

In sum, Pearson and Steinbacher conclude, marketplace lenders are currently subject to an increase in regulatory scrutiny, and thus it is essential for marketplace lenders to mitigate risk through comprehensive compliance assessments with the aim of addressing these concerns.