Diverging approaches to regulating EWA; FSB toolkit for third-party risk management; Connecticut's amended law and "true lender" requirements; and updates on AI, privacy, and more
Welcome to the next issue of Legal-tender: Your fin-tastic guide to the legal side of crypto and fintech.1
For this newsletter, I write about the following:
States adopt diverging approaches regarding earned wage access.
Third-Party Risk Management and worldwide alignment.
California governor’s generative AI order.
Quick Hits (privacy, MTLs, crypto, and CFPB).
If you enjoy my newsletter, please subscribe and share!
The Diverging State Regulatory Landscape for Earned Wage Access
TL/DR: States are beginning to address earned wage access (“EWA”) directly. States like Missouri and Nevada are taking a targeted approach, drafting requirements specific to EWAs. Other states, like Connecticut and Maryland, conclude that certain EWAs are “credit” and should be regulated under standard loan laws. Treating EWAs as credit may lead to fewer opportunities for employees to access earned wages early in such states.
Intro: EWA allows employees early access to wages they have already earned but have yet to be paid. States are taking divergent approaches to regulating these services.2 While Nevada and Missouri explicitly exclude specified EWAs from credit regulations, Connecticut and Maryland put certain EWAs under their lending laws’ authority. Further, California is proposing regulations that treat EWAs as “credit” and subjecting them to one of two laws. This fragmented regulatory approach risks reducing access—and possibly affordability—for the employees EWAs aim to help.
This article will describe (1) what EWA is, (2) the approaches states are taking to regulate EWAs, and (3) why different regulatory treatment across states hinders the development of EWAs and may lead to employees receiving fewer or worse options to receive earned wages.
[Note: Jason Mikula from Fintech Business Weekly has an insightful post on EWA from a few weeks ago, here; his publishing cadence is obviously stronger than mine, and hope to add value beyond his post in discussing the nature of regulatory approaches + why treating EWA as credit may be counterproductive.]
What is Earned Wage Access?
EWA programs permit employees to receive earned wages not yet paid before the employee’s next scheduled payday. EWA products typically fall within one of three categories:
Employer-to-employee model: In this variation, the employer funds the EWA and may use a third party to help facilitate the process, but the third party never uses its funds at any stage.
Employer-integrated model: In this variation, a provider enters into an agreement with the employer and integrates with the employer’s timekeeping system. The provider frequently makes the advance to the employee rather than the employer. The employee repays the advance through a payroll deduction that the employer sends to the provider (with some variations on how this is operationalized) or by a debit to the employee’s bank account on the pay date.
Direct-to-employee model: In this variation, the provider directly offers the service to the employee, typically without any agreement with the employer. The provider typically uses various methods to determine an employee’s wages, such as through uploaded time sheets. The employee repays the advance through a debit to the specified account.
Each model typically has the following common characteristics:
the provider or employer frequently restricts the amount of earned wages the employee can access and, in no case, allows the employee to access unearned wages.
the transaction is non-recourse, meaning the provider or employer has no legal recourse against the employee.
the employer or provider will not engage in debt collection activities against the employee regarding the EWA transaction.
How is Earned Wage Access Regulated?
A fundamental question in determining how EWA is regulated is whether an EWA transaction is a credit or non-credit transaction. Until recently, no state had enacted EWA-specific legislation answering this question.3 Nevada and Missouri recently did so, and both expressly do not treat specified EWA products as credit. Further, the Arizona attorney general issued an opinion in late 2022 that EWAs that met certain criteria—including being non-recourse and not imposing finance charges—are not loans.
On the other end, Connecticut amended its legislation to expressly include earned wages that are advanced before payday into its definition of a “small loan” and re-inforced this interpretation in recently issued guidance. California issued proposed regulations that treat EWA products as credit and would subject them to either the California Consumer Financial Protection Law or the California Financing Law. Maryland released guidance that only expressly included employer-funded EWAs from its loan laws while cautioning that any product involving a service provider may be treated as a loan.
Below, I describe the approach that Nevada and Missouri took, briefly describe the changes to Connecticut’s law and Maryland’s guidance, and conclude by discussing why I believe Nevada’s and Missouri’s approach is better for states to adopt. If the result is that some states treat EWA as non-credit while some states apply credit requirements. In that case, employees in the latter states will likely have fewer alternatives for accessing earned wages, and their options will likely be pricier.
Earned Wage Access as not credit
Nevada (SB 290) and Missouri (SB 103) enacted legislation whereby EWA providers must be licensed or registered, respectively, and must meet substantive obligations. Both laws apply to employer-integrated models and direct-to-employee models. Notably, both laws expressly state that EWA products are not credit nor loans and that fees are not interest or a finance charge (Nevada does not expressly state that gratuities and tips are not interest or a finance charge,4 while Missouri does).
Regarding substantive requirements that Nevada and Missouri impose on providers, a comprehensive analysis is beyond the scope of this article, but briefly, each law addresses:
Disclosures: EWA providers must inform employees of their rights under an EWA agreement and disclose all fees associated with the EWA program.
Repayment from account at a depository institution: If the EWA provider seeks repayment of the EWA from an employee’s bank account via an electronic fund transfer, the EWA provider must comply with the Electronic Fund Transfer Act and its implementing regulation, Regulation E. The EWA provider must fully reimburse the employee for any overdraft or NSF fee the employee incurs if the EWA provider sought payment on a date before, or in an incorrect amount, the date or amount disclosed to the employee.
Voluntary tips, gratuities, or donations: If the employee can compensate an EWA provider with a voluntary gratuity, then the EWA provider must:
Clearly and conspicuously disclose/provide an option that a tip, gratuity, or donation may be zero.
Conspicuously disclose/refrain from making representations that tips, gratuities, or donations will benefit any specific person.
Further, each law prohibits the EWA provider from compelling repayment from an employee by (i) filing a lawsuit/civil action against the employee, (ii) using a third party to pursue collection on the EWA provider’s behalf, or (iii) selling an outstanding EWA or outstanding amounts to a third party collector or debt buyer.
Note, again, that this is a high-level overview. Each state has additional requirements, and a careful understanding of the requirements is necessary before operating in either state.
The Missouri law took effect on August 28th, while the Nevada law will take effect on July 1, 2024.
Earned Wage Access as credit
Connecticut recently amended its law to expressly include earned but not yet paid wages within its definition of a “small loan,” Maryland released guidance concluding that Maryland law “requires a case-by-case analysis for those products provided by employers but through a connected third party.”
Connecticut further released guidance on how and when EWA products are within the scope of Connecticut’s Small Loan Lending and Related Activities Act. In short, the advance must be under $50,000 with an APR—now calculated using the MAPR calculation under the Military Lending Act—of 12% or higher. EWA products that meet these thresholds will be subject to licensing requirements and certain interest rate and fee limitations. Connecticut’s revised law takes effect on October 1, 2023.
Maryland’s guidance states that its Office of Financial Regulation will consider the following three factors when assessing whether the third party is a service provider to the employer or a lender:
Who bears the economic risk?
e.g., is the third party or the employer at economic risk if the employee fails to pay?
What level of contact does the third party have with the consumer?
e.g., the greater contact by a third party with the employee, the less the third party is seen as a service provider to the employer.
Who benefits from any fees or “tips” the consumer pays?
If an EWA product is considered a “loan,” the provider will be subject to licensing requirements and certain interest rate and fee limitations.
Concluding Thoughts
Subjecting EWA products—at least those that are non-recourse, not reported to credit agencies, no late fees, can’t be sold to debt buyers, etc.—to credit laws strikes me as the wrong approach. Instead, approaches like those taken in Nevada and Missouri better reflect the risks associated with EWA products while permitting employees the agency and capability to decide the best method to receive wages early.
Subjecting EWA products to credit laws would likely erode the protections consumers currently have—such as the wage access being non-recourse—and replace them with many of the current components that people find objectionable about payday loans or other forms of short-term credit: high fees, penalties resulting from delinquency, “cycles” of debt, and other potential harms.
Aligning Third-Party Risk Management Worldwide
How should financial institutions and regulators worldwide align to govern third-party risks? This issue intersects with innovation, resilience, and financial stability.
The Financial Stability Board recently detailed a toolkit for institutions and authorities to manage third-party risks, particularly critical services that may impact stability. Rather than solely summarizing this toolkit, I thought comparing this global approach with the specific practices for US banks outlined in the interagency guidance would be helpful. The most interesting contrast was the FSB’s emphasis on critical services, whereas the interagency guidance provided even less guidance on this concept than individual regulators previously did.
Scope:
The interagency guidance focuses solely on third-party relationships at banks (obviously those in the US).
The FSB toolkit is broader, looking at financial institutions and financial authorities.
Specificity:
The interagency guidance contains more detailed practices and processes for US banks around due diligence, contracts, monitoring, governance, etc.
The FSB toolkit has higher-level tools and guidance to promote aligned international approaches.
Critical services:
The interagency guidance discusses critical activities but does not focus primarily on critical third-party services.
The FSB toolkit emphasizes critical services that could impact financial stability.
Authorities role:
The interagency guidance covers regulators' expectations and oversight of US banks.
The FSB toolkit delves deeper into authorities identifying and managing systemic risks and dependencies.
In summary, the interagency guidance is more hands-on, while the FSB toolkit aims for standard international tools and cooperation on systemic risks. But, they have consistent goals around effective third-party risk management.
I expect greater international collaboration on third-party risk management; toolkits from international bodies like FSB will be valuable to US regulators and to US financial institutions as they seek to better discern regulators' concerns and how they expect financial institutions to address those concerns.
Connecticut’s Amended Lending Law Seeks to Regulate the “True Lender”
In addition to addressing EWA, Connecticut’s revisions to its Small Loan Lending and Related Activities Act also require licensure for agents or service providers of exempt lenders if they act as the “true lender.” To determine when an agent or service provider is acting as the “true lender,” Connecticut relied on laws enacted in Illinois,5 Maine,6 and New Mexico7 as well as case law analyzing the issue.8
The law states that the following circumstances weigh in favor of deeming the person a lender who requires licensure:
Indemnifying, insuring or protecting an exempt person for any costs or risks related to a small loan;
predominantly designing, controlling or operating a small loan program; or
purporting to act as an agent, service provider or in another capacity for an exempt person in this state while acting directly as a lender in another state.
As noted above, the law takes effect October 1, 2023.
California governor issues Executive Order on Generative AI
The executive order directs state agencies to examine the use of generative AI tools in government, develop guidelines for procurement and use of AI, protect against risks, and prepare the state workforce for emerging AI technologies through training and partnerships with universities. It aims to support responsible AI innovation that improves services for Californians while mitigating risks like bias and protecting privacy. The order also calls for evaluating AI's impact on regulatory issues and periodically updating recommendations as the technology evolves.
Quick Hits (privacy, MTLs, crypto, and CFPB)
Use of Alternative Data: The GAO sent letters to the OCC, FDIC, and FRB following up on its recommendations concerning the appropriate use of alternative data.
We recommended that the Federal Reserve, other federal banking regulators, and the Consumer Financial Protection Bureau communicate the appropriate use of alternative data in the underwriting process with banks that engage in third-party relationships with fintech lenders. Implementing our priority recommendation in this area could better position federally regulated banks to manage the risks associated with partnering with fintech lenders that use these data.
Privacy
“The California Privacy Protection Agency’s (CPPA) Enforcement Division today announced a review of data privacy practices by connected vehicle (CV) manufacturers and related CV technologies. These vehicles are embedded with several features including location sharing, web-based entertainment, smartphone integration, and cameras. Data privacy considerations are critical because these vehicles often automatically gather consumers’ locations, personal preferences, and details about their daily lives.”
CA AG seeking information from California employers on compliance with CCPA:
California Attorney General Rob Bonta today announced an investigative sweep, through inquiry letters sent to large California employers requesting information on the companies’ compliance with the California Consumer Privacy Act (CCPA) with respect to the personal information of employees and job applicants.
Virtual Assets
Letter from Sen. Brown to SEC, Treasury, and CFTC:
Without consistent, comprehensive, and accurate disclosures in crypto markets, users are left vulnerable. When both legitimate and illegitimate market activities are opaque, consumers and investors cannot readily distinguish fraud and scams from other token projects. The result is the Wild West of investing—an ecosystem that invites and rewards both bad actors and shoddy products. By contrast, mandatory, universal disclosures smoke out bad actors and shoddy products alike.
Money Transmission
Miscellaneous
“Nasdaq (NDAQ) is dropping its plans for a crypto custody service, which was slated to go live in the second quarter of this year, CEO Adena Friedman said in an earnings call on Wednesday.”
CFPB and Commissioner for Justice and Consumer Protection of the European Commission begin an informal dialogue on “critical financial consumer protection issues.” This includes automated decision-making and processing of data, BNPL, and “Big Tech.”
FCA issues new proposals on financial promotions on social media: “A meme that constitutes a non-compliant cryptoasset promotion.”
As discussed above, the FTC is initiating public enforcement actions against crypto companies. And the FTC recently published updates to its Endorsement Guides. I would not be surprised if the FTC is internally focusing on cryptoasset promotions here.
I am providing this information generally; this information is not legal advice and is not intended to apply to any specific legal or factual situation. You are not forming an attorney-client relationship with me or Ketsal PLLC by reading or subscribing to this newsletter. These views are my own—especially the wrong ones—and do not represent Ketsal. If you need legal advice or have questions requiring an attorney, please reach out to an attorney you trust.
One caveat to this statement is the language found within states that have adopted the Uniform Consumer Credit Code (“UCCC”) or variations on the Uniform Small Loan Law. These laws don’t expressly address EWA as a distinct approach to accessing earned but unpaid wages. Still, depending on the program's structure, such laws could potentially apply to EWA programs.
For example, UCCC states, such as Kansas, adopted this or similar language:
(1) A creditor may not take an assignment of earnings of the consumer for payment or as security for payment of a debt arising out of a consumer credit transaction. An assignment of earnings in violation of this section is unenforceable by the assignee of the earnings and revocable by the consumer. This section does not prohibit an employee from authorizing deductions from his earnings if the authorization is revocable.
(2) A sale of unpaid earnings made in consideration of the payment of money to or for the account of the seller of the earnings is deemed to be a loan to him secured by an assignment of earnings.
Comments to this law state, “A revocable payroll deduction authorization in favor of a creditor is not forbidden by this section so long as the requisite notice is given to the consumer of his right to revoke.”
Note that I chose Kansas of all the UCCC states because its Office of the State Bank Commissioner issued an opinion to FlexWage concluding that its services do not require a supervised loan license because of “employer funding, no advancement of unearned wages, and the lack of a repayment obligation.”
Note that the CFPB issued an advisory opinion in 2020 regarding applying the Truth in Lending Act and its implementing regulation, Regulation Z, to EWA products. The CFPB’s opinion covers solely employer-integrated models. Further, this opinion was issued under prior leadership, and it is unclear whether the current leadership adopts this reasoning, though the opinion has not been rescinded.
Interestingly, the Government Accountability Office released a FinTech report in early 2023 recommending that the CFPB further clarify its stance on EWA products, including whether any such products constitute “credit.” The CFPB agreed with this recommendation, but to date, no action has been taken, including reaffirming its stance on the 2020 opinion.
Nevada states that fees provided to a consumer by a provider are not to be deemed interest or a finance charge. The definition of “fee” excludes tips, gratuities, and donations. The rest of the language implies that voluntary payments should not be treated as interest or a finance charge. Missouri is clearer, and its law reads, “Fees, voluntary tips, gratuities, or other donations shall not be considered interest or finance charges.”
815 ILCS 123/15-5-15.
9-A M.R.S. § 2-702.
N.M. Stat. Ann. § 58-15-3.
While the Department of Banking’s industry guidance cites two cases, no uniform or bright-line test exists for analyzing whether an agent or service provider to a financial institution is the “true lender.” The closest bright-line test is likely the “predominant economic interest” analysis, but that remains heavily fact dependent.