Smooth Transitions - Navigating Wind-Down Provisions (plus non-SVB recent regulatory developments you may have missed)
Hey all,
Welcome to the next issue of Legal-tender: Your fin-tastic guide to the legal side of crypto and fintech.1
Clearly, nothing has been happening in the fintech/crypto space in the last few weeks…
For this newsletter, I want to focus on some critical thoughts and stories that may have gotten lost (or be magnified) in all the SVB and Signature Bank happenings.
First, I write about wind-down periods in contracts.
Second, I highlight the South Dakota Governor’s unfortunate veto of UCC Article 12.
Third, I address two recent speeches by FRB Governor Bowman and her remarks recommending shifting the regulatory burden from banks to fintechs.
Fourth, the GAO released a report on Fintechs, which contains a recommendation on earned wage access + CFPB report on BNPL.
Fifth, the CFPB released a Request for Information on Data Brokers and Other Business Practices Involving the Collection and Sale of Consumer Information.
Sixth, the FRB announced a release date for FedNOW + Democratic senators express concern over fraud on Zelle (and I see no reason why fraud rates would be different for FedNOW vs. Zelle; hence the connection here).
Smooth Transitions - Navigating Wind-Down Provisions
This tweet inspired my main story for this issue:
Patrick—and if not following him or his newsletter, PSA to do so!—was writing about FTX and the relationship counterparties now have to it versus who they originally entered into contracts with.
His following tweet, however, is a tad unfair, IMO. It’s not a “We Told You So,” or at least that’s not how I think of it. The issue can be both prospective and retrospective.
So, in that vein, I want to write about one issue that we’ve seen arise recently - winding down a program when a relationship ends, either naturally or prematurely.
Many contracts incorporate wind-down provisions, so this article isn't a reminder to include them. Instead, I want to emphasize two points: (1) careful consideration is required when incorporating these provisions, as what's suitable for one party may not be for another; and (2) well-crafted wind-down provisions aren't the ultimate goal - successful execution is the desired result.
But first, a hypothetical contemplating a successful wind-down plan:
Let's consider a fintech company, Fintech McFintechFace, that has partnered with Banky McBankFace to offer its customers a digital banking solution, including checking accounts and debit cards. Fintech McFintechFace’s platform relies on Banky McBankFace's banking infrastructure and regulatory compliance to deliver these services.
Over time, Banky McBankFace faces increased regulatory scrutiny due to compliance issues unrelated to its partnership with Fintech McFintechFace. The regulatory authorities impose stricter capital requirements on Banky McBankFace and mandate that it scales back its partnerships with third-party vendors, including fintech companies, to focus on its core banking operations and remediation efforts.
As a result, Banky McBankFace decides to terminate its partnership with Fintech McFintechFace, invoking the wind-down provision in their contract. The wind-down provision specifies that Banky McBankFace must provide Fintech McFintechFace with a 90-day notice period to find an alternative banking partner and transition its services.
During the wind-down period, both Fintech McFintechFace and Banky McBank Face work together to ensure a smooth transition for their customers. They jointly communicate the changes to customers, assist customers in switching their accounts to the new banking partner, and ensure that any outstanding loan balances or pending transactions are appropriately managed.
In this hypothetical situation, the wind-down provision is crucial in facilitating an orderly transition and minimizing disruptions to Fintech McFintechFace's operations and customer experience. By having a well-drafted wind-down provision in place, Fintech McFintechFace and Banky McBankFace can manage their legal and operational risks during the termination of their partnership.
Wind-Down Provisions
No one at the outset of a significant commercial relationship relishes contemplating its ending. But commercial relationships end. And quite frequently, they end naturally. For instance, one party might outgrow the partnership, necessitating a different platform and a legally simple migration (though operationally challenging!)
Regrettably, considering a "difficult split" is a valuable risk appraisal for both parties. Failing to successfully navigate a wind down can lead to significant risks, including financial losses, reputational damage, or legal disputes.
When drafting wind-down provisions, consider some of these best practices:
Ensure clarity and specificity by outlining each party's responsibilities, rights, and obligations during the wind-down process, including notice periods, transition assistance, and access to necessary data or resources; and
Build flexibility to account for the varying circumstances under which the wind-down may occur, such as regulatory changes, business strategy shifts, or termination for cause.
Utilizing the Wind-Down Provision
Assuming the contract has a well-written and enforceable wind-down clause, an urgent step is beginning the wind-down. Navigating a successful wind-down is in both parties interest - consumers should experience the least amount of disruption possible if migrating to a new partner, or if the program is ending, consumers should be provided plenty of time to arrange for alternatives.
Following SVB’s collapse (and even earlier, with the Blue Ridge OCC order), fintechs should be considering who they would transition to if needed. It can be challenging to find an initial partner. The negotiations, technical integrations, and all the other work that goes into making the partnership work and get launched are hard! Even thinking of finding a second partner can be daunting, much less doing so.
(Note - I am not recommending that every fintech enters into arrangements with multiple parties to ensure smooth business continuity should the fintech be forced to leave its primary partner; I am recommending that fintechs be aware of what additional options exist for them, and which other partners may be suitable should the need arise. This can solely be a thought exercise, contingent on the nature of the fintech’s business and many other factors.)
Finally, even though it may be in both parties' interest to have a smooth wind-down, the bank partner will still need to meet its obligations. And fine, Patrick was right - here’s where you want your previously drafted agreement to protect you (e.g., through a remedy should the bank fail to meet its obligation and it causes you, your consumers, or both, harm).
Overall, effective communication and cooperation can help mitigate risks, address unforeseen challenges, and ensure a more seamless transition. If parties need to wind down an agreement, addressing each party’s needs at the outset of the wind down will likely lead to greater satisfaction. One best practice is establishing a clear timeline and assigning responsibilities for each phase of the wind-down process, which can provide a roadmap for both parties. Additionally, maintaining open lines of communication and promptly addressing any concerns or disputes as they arise can further promote a successful transition.
Legal plug: Engaging experienced and trusted legal counsel is essential when drafting and negotiating wind-down provisions, as well as during the execution of the wind-down process. A knowledgeable attorney can provide valuable insights into industry-specific best practices, help navigate complex regulatory requirements, and ensure that the provisions are tailored to the unique needs and risks of the partnership. With knowledgeable legal counsel, both parties can better protect their interests, minimize potential liabilities, and foster a more seamless transition if the wind-down provisions need to be invoked.
South Dakota Governor Vetos Article 12
In an incendiary headline and press release, Governor Kristi Noem of South Dakota vetoed House Bill 1193—which was to enact Art. 12 and other corresponding changes to the UCC—because it “attack[s] Economic Freedom.” The bill did the opposite - it enabled economic freedom. The governor’s attack on the bill starts from a misunderstanding of Art. 12 of the UCC - “By expressly excluding cryptocurrencies as money, it would become more difficult to use cryptocurrency.”
Two of the most intelligent people thinking and writing on Article 12 have already published excellent materials on this misunderstanding, in the hopes—fingers crossed—that other governors or legislatures won’t make similar misunderstandings.
First was Professor Carla L. Reyes, an assistant professor at SMU law school. She wrote a terrific tweet thread and follow-up paper highlighting the development of Article 12, including what it does—and importantly—does not do. To quote:
the UCC is private law - it is not regulatory in nature, and the definition of money in the UCC has no direct impact on the definition of money for other legal purposes such as in the Internal Revenue Code, the Bank Secrecy Act, Money transmitter laws…
Second was Drew Hinkes, a partner at K&L Gates. He writes an excellent thread providing a “top 10” list of effects.
If interested in Article 12, please read these. Even if you think you know Article 12 well, these are useful.
Both emphasize that Art. 12 is private law. My only minor contribution to what they wrote is to briefly describe why this distinction is important.
Private law is different than public law. Public law defines the powers, rights, and responsibilities of public authorities and how they interact with citizens or organizations. Public law includes constitutional law and administrative law, for example. Public laws are generally applicable.
Private law, on the other hand, governs relationships and disputes between private individuals, organizations, and entities. Contract law and property law are types of private law. These are the laws Article 12 and corresponding changes to the rest of the UCC add to or modify.
Hopefully, Governor Noem’s veto is just a speed bump as enacting a uniform approach to “controllable electronic records” becomes more necessary by the day as more and more entities and persons seek to transact using CERs, often not understanding the legal risks they may be taking by relying on existing UCC articles.
FRB Governor Bowman gives two speeches recommending shifting regulatory burden towards fintechs
On February 15th and March 14th, FRB Governor Michelle Bowman gave remarks addressing, in part, third-party oversight and management. While her remarks are interesting on a few levels—she repeated that the prudential regulators are reviewing comments from their interagency proposed rule on third-party relationships—the most interesting point for me was her stated desire to shift the regulatory burden onto fintechs from banks, especially smaller banks.
The Bank Service Company Act gives the federal banking agencies significant regulatory authority over outsourced banking services. In a world where third parties are providing far more of these services, it seems to me that these providers should bear more responsibility to ensure the outsourced activities are performed in a safe and sound manner.
We’ll likely have to wait and see if the prudential regulators finalize their proposed rule to see if any changes are formal. But overall, the tenor from regulators recently has been looking to place greater burden for compliance on the fintechs.
GAO Report on Fintech + CFPB report on BNPL
GAO Report
The GAO issued a study on fintechs to determine the benefits and risks of fintech offerings. The report
examines (1) the benefits, risks, and limitations of selected fintech products for underserved consumers, and what is known about the extent to which underserved consumers have used them, and (2) federal and state regulators' steps to assess selected fintech products.
The GAO found that while fintech products offer benefits to underserved consumers, they also pose certain risks. The GAO highlighted the risk posed by earned wage access products, noting that “the costs of the product may not be transparent, and there may be risks of unexpected overdraft fees.”
To remedy this, the GAO recommended that the “CFPB issue clarification on the application of the Truth in Lending Act's definition of “credit” for earned wage access products not covered by its November 2020 advisory opinion.” The CFPB agreed. The status for the “recommendation” is “open.” So expect further guidance from the CFPB on this issue.
CFPB BNPL Report
The CFPB recently issued a CFPB Office of Research Publication No. 2023-1 on the Consumer Use of Buy Now, Pay Later.
The CFPB's report on BNPL services provides several key takeaways that highlight existing regulatory concerns:
Highly indebted borrowers: The report found that BNPL borrowers, on average, were more likely to be highly indebted compared to non-BNPL borrowers. This reinforces concerns about BNPL services potentially exacerbating consumer debt.
Delinquencies and high-interest financial services: BNPL borrowers were more likely to have delinquencies in traditional credit products and use high-interest financial services like payday loans, pawn, and overdrafts, indicating potential financial stress among this group of consumers.
Higher credit card utilization and lower credit scores: The report found that BNPL borrowers had higher credit card utilization rates and lower credit scores than non-BNPL borrowers, which may raise concerns about the credit risk assessment practices of BNPL providers.
Access to traditional forms of credit: Contrary to popular belief, BNPL borrowers generally have access to traditional credit options. They were more likely to use credit and retail cards, personal loans, student debt, and auto loans compared to non-BNPL borrowers. This finding suggests that BNPL services are not solely catering to underserved consumers and may pose risks even to those with access to traditional credit.
Credit card interest rates: The report estimates that a majority of BNPL borrowers would face credit card interest rates between 19 and 23 percent annually if they had chosen to make their purchase using a credit card. This finding highlights that BNPL services might be attractive to consumers seeking to avoid high interest rates.
CFPB Request for Public Comment on Data Brokers
The CFPB published a Request for Public Comment on data brokers for two reasons (emphasis added):
(1) help inform the CFPB about new business models that sell consumer data, including information relevant to assessments of whether companies using these new business models are covered by the FCRA, given the FCRA's broad definitions of “consumer report” and “consumer reporting agency,” or other statutory authorities, and (2) collect information on consumer harm and any market abuses, including those that resemble harms Congress originally identified in 1970 in passing the FCRA.
Despite use of the word “sell” there, the CFPB describes data brokers as an “umbrella term” that includes “firms that collect, aggregate, sell, resell, license, or otherwise share consumers' personal information with other parties.” The CFPB further gives an example of a data broker as an entity that collects information for “consumer-authorized data porting.”
Especially interesting is the CFPB’s view regarding “data aggregators,” or entities that enable “open banking,” especially those entities that enable consumer access to data under Dodd-Frank’s 1033, and which the CFPB is currently undergoing a rulemaking process. The CFPB appears to potentially consider them within the realm of “data brokers” even if they don’t “sell” consumer data.
The CFPB seeks comment on 22 questions related to “Market-Level Inquiries,” such as “Which specific entities and types of entities collect, aggregate, sell, resell, license, or otherwise share consumers' personal information with other parties?”
The CFPB also seeks comment on 7 “Individual Inquiries,” such as “Have you experienced data broker harms, including financial harms? What are those harms?”
Federal Reserve Announces Launch for FedNow
The Federal Reserve announced that FedNow will start operating in July. Time permitting, I’ll write a longer piece on the status of real-time payments in the U.S. before FedNow launches.
With that said, I’m ultimately skeptical of the impact of FedNow. RTP has been around since 2017, and is operated by the Clearing House. While, at least anecdotally, I’ve heard it’s gaining more traction for commercial transactions, it is not widely used for consumer payments. To help spur adoption of FedNow, the Federal Reserve “will discount certain FedLine fees to $0.00 to support testing activities and streamlined onboarding processes.”2
However, the Federal Reserve cannot keep reduced prices for extended periods because under the Monetary Control Act, the Federal Reserve Board must set fees to “recover, over the long run, all direct and indirect costs and imputed costs, including financing costs, taxes, and certain other expenses, as well as the return on equity (profit) that would have been earned if a private-sector business provided the services.”3
Maybe, as some have theorized, FedNow will make “bank runs” even more of a risk. Probably not what the Federal Reserve had in mind when creating FedNow. And I won’t even mention fraud concerns…But certain Democratic senators recently wrote a letter to the Federal Reserve, FDIC, NCUA, and OCC regarding fraud on the Zelle network…
I am providing this information generally; this information is not legal advice and not intended to apply to any specific legal or factual situation. By reading or subscribing to this newsletter, you are not forming an attorney-client relationship with me, or with Ketsal PLLC. 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.
Id. at 79,310.