In a surprising decision, a New York federal district court not only refused to dismiss the New York Department of Financial Services’ (DFS) challenge to the Office of the Comptroller of the Currency’s (OCC) plans to issue special purpose national bank (SPNB) charters to fintech companies, but it also telegraphed an eventual victory for DFS on the merits. Specifically, the court found that “the term ‘business of banking,’ as used in the [National Bank Act], unambiguously requires receiving deposits as an aspect of the business.” If so, SPNB charters are not authorized by the National Bank Act (NBA), since the OCC’s July 2018 Licensing Manual Supplement largely restricts the availability of SPNB charters to fintech companies that do not plan to take deposits.
Although technically the decision merely allowed DFS to move forward with two of its three claims and did not rule in favor of DFS on the merits, the court’s ruling agrees with the central premise underlying DFS’s lawsuit. For that reason, the OCC may well pursue an interlocutory appeal or agree to an adverse judgment to expedite an appeal to the Second Circuit. In the meantime, there will be continued uncertainty regarding the value of an SPNB charter, and perhaps greater focus by fintechs on other strategic options such as alternative charters and enhanced bank partnership structures.
What happened
The dispute dates back to 2016, when the OCC initially considered whether to accept applications from fintech companies for SPNB charters. The agency received mixed comments on its proposal and published draft licensing standards in 2017.
In response, both the DFS and the Conference of State Bank Supervisors (CSBS) filed suit to challenge the proposal, which would permit fintechs to originate loans and access the payment system directly without relying on third-party banks or obtaining a separate license in each state where customers are located.
However, the OCC was successful in its motions to dismiss both lawsuits when courts determined that the plaintiffs’ claims were not ripe for judicial review.
The cycle began all over again last July, when the OCC announced that it would begin accepting applications for the SPNB charters, and both the CSBS and the DFS filed another round of lawsuits. The OCC again filed motions to dismiss both actions.
But this time, U.S. District Judge Victor Marrero denied the OCC’s motion to dismiss the DFS case, finding that the state regulator had sufficiently demonstrated “a substantial risk that harm will occur” to satisfy Article III standing for the suit and rejecting the OCC’s argument that the case was not ripe for review, concluding that the federal agency has done enough to bring its plan for SPNB charters under judicial scrutiny.
Repeatedly emphasizing the importance of the nation’s dual banking system, the court noted its “key feature” that “any entity that is not a deposit-receiving bank—including non-depository fintech companies—is left largely to the prerogative of the states to regulate.”
Judge Marrero agreed that the DFS sufficiently alleged that the fintech charter decision “upsets the balance” of the dual banking system in two ways: with New York citizens losing financial protections provided by state banking law and regulatory oversight, and the DFS itself suffering direct economic harm with the deprivation of revenues from future assessments levied upon its licensed institutions that move to the OCC.
“These alleged threats to New York and the DFS implicate the type of sovereign and direct interests common in cases where states have standing to contest agency action,” the court said. “New York provides a comprehensive regulatory system for non-depository fintech companies – a system allegedly threatened by OCC’s course of action at issue in this case.”
Declining to delineate precisely when a threat to a state’s ability to create and enforce laws becomes ripe, the court nevertheless found DFS’s claims both constitutionally and prudentially ripe for adjudication.
“As a result of the fintech charter decision, New York State’s regulations for over ‘600 non-bank financial services firms’ are all at risk of becoming null and void,” Judge Marrero wrote. “Of course, certain steps, namely the application for, and then the granting of, an SPNB charter must occur before a fintech firm can flout New York’s law. But those steps do not stymie DFS’s standing.”
DFS’s allegations that the OCC has invited fintech companies to its offices to discuss the SPNB charters indicates “at least some demand for, and interest in, such charters,” the court added.
This alleged interest, “coupled with the common-sense observation that OCC spent numerous years developing the fintech charter decision and coordinating its creation with other federal banking regulators indicates that OCC has the clear expectation of issuing SPNB charters,” the court said.
In light of these expectations, “DFS had demonstrated a ‘substantial risk that the harm will occur,’” the New York federal court wrote, including the risk that entities may leave its supervision to seek greener pastures. “Such risks will color all agency action until this dispute is resolved. And such risks will force DFS to incur costs now to ‘mitigate or avoid’ the harms that currently unlawful lending practices might bring under OCC’s supervision, for example.”
Judge Marrero adopted a pragmatic approach to the situation, recognizing that the question raised by the lawsuit “supports answering it before a fintech company wastes its and OCC’s time and money obtaining an SPNB charter.”
The court further determined that DFS’s challenge to the OCC’s authority under Section 5.20(e)(1) was not untimely, applying “the reopening doctrine,” which permits courts to review recent agency action based on prior agency interpretation. Although the federal agency amended its regulations to add Section 5.20 in 2003, it has never chartered a national bank that does not take deposits, nor has it pointed to guidance prior to the fintech charter decision regarding what that process might be, the court said.
Since DFS could not have brought a ripe claim any earlier, the court found the OCC failed to carry its burden on the timeliness argument.
As for the OCC’s attempt to dismiss the case based on substantive authority, the court was not persuaded that deference was owed to the agency’s interpretation of the “business of banking” as used in the NBA, finding that the term was not ambiguous.
“The court finds that the term ‘business of banking,’ as used in the NBA, unambiguously requires receiving deposits as an aspect of the business,” Judge Marrero concluded.
Considering dictionary definitions from the time of the NBA’s drafting and the frequency of the original statute’s discussion of the deposit-receiving function of national banks, the court found it “illuminating” that Congress explicitly amended the NBA—on two occasions—to authorize the OCC to issue bank charters to a type of non-depository institution.
“The court infers from these two enactments that the amending Congresses understood the NBA’s original use of the ‘business of banking’ phrase to require deposit-receiving, such that a non-depository institution (or class of such institutions) is not considered eligible to be granted a federal charter to commence the ‘business of banking’ absent a statutory amendment to the contrary,” the court wrote. “If those Congresses had a different understanding of the prerequisites for a national bank charter, it is unclear why they would have acted to confer upon OCC an authority they believed OCC already possessed.”
Bolstering the court’s conclusion: the OCC’s attempt to claim the power to charter non-depository institutions as national banks in 2003, some 140 years after the adoption of the statutory language that is that power’s putative source. “The court finds that a delay of that length provides substantial grounds to cast doubt on OCC’s interpretation,” the court wrote, particularly in light of DFS’s allegations about upsetting the proper balance of federal and state functions and powers in the dual banking structure.
“The court concludes that the NBA’s ‘business of banking’ clause, read in the light of its plain language, history and legislative context, unambiguously requires that, absent a statutory provision to the contrary, only depository institutions are eligible to receive national bank charters from OCC,” Judge Marrero wrote.
While the court denied the motion with respect to the majority of DFS’s claims, it did side with the OCC to dismiss the plaintiff’s Tenth Amendment claim.
Why it matters
This is not your garden variety preliminary ruling. On the heels of the dismissals of the prior challenges to the OCC’s SPNB charter plan, the breadth of the decision denying the federal agency’s motion to dismiss comes as a surprise and puts the future of the charter plans in doubt, at least for the moment. Judge Marrero not only found that the DFS had established standing and that its claims were now ripe for review, but further refused to dismiss based on the merits of the plaintiff’s claim, concluding that the “business of banking” unambiguously requires receiving deposits pursuant to the NBA. The dispute will continue, as the OCC may seek interlocutory review with the U.S. Court of Appeals, Second Circuit. As the OCC put it, the court’s order “likely renders the matter ripe for entry of final judgment,” and has requested “additional time to complete our internal deliberations on this issue and confer with plaintiff’s counsel.” Meanwhile, the OCC still faces the nearly identical CSBS action in Washington, D.C., federal court, which remains active pending the OCC’s motion to dismiss. Although the New York decision was submitted as supplemental authority in that case, it remains possible that the outcome will differ.
As the New York and D.C. cases play out, fintechs evaluating strategic options may wish to consider alternative charters, such as a full national bank charter or a state industrial bank charter, or revisit their bank partnership structures to reduce Madden and true lender risk. We welcome your questions in this regard.