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2019 Outlook: CFPB Innovation Policies May Face State Challenges

Dec. 28, 2018, 10:34 AM

The Consumer Financial Protection Bureau is aiming to launch the first federal sandbox in the new year and roll out other policies to encourage financial services innovation.

The goal of the “regulatory sandbox” and no-action letter policies is to spur innovation in lending and payments by exempting participating companies from some consumer finance laws. In exchange, the CFPB would ease up on enforcement actions against companies for potential violations of consumer finance laws.

For some fintech proponents, the CFPB’s sandbox is a critical initiative to help regulators learn more about innovative products. The proposals are expected to be finalized in the first half of 2019, after which companies could apply for enforcement exemptions.

The proposals call for federal and state regulators to collaborate to help make companies’ participation in the programs more seamless. “You’re only as innovative as your least innovative regulator,” Rob Morgan, vice president of emerging technologies at the American Bankers Association, told Bloomberg Law.

Financial institutions are cautious of falling afoul of their multiple regulators. The program’s success could hinge on whether other regulators take the CFPB up on its coordination offer.

But with the CFPB pulling ahead of other federal and state regulators in offering the programs, the agency is also teeing up potential conflicts down the line.

Potential Collaboration

The new year may bring new partnerships between states and the CFPB. Arizona’s attorney general launched a fintech startup sandbox in 2018. The attorney who helped design that sandbox structure, Paul Watkins, now leads the CFPB’s Office of Innovation, making Arizona a likely candidate for a first state partner with the CFPB. Other states could follow suit in 2019 as state legislatures and regulators explore the idea of regulatory sandboxes.

The CFPB’s commitment to coordinating regulation is “unusually proactive” and part of the “boldest step yet” by a federal agency to set up a meaningful regulatory sandbox, Laurel Loomis Rimon, senior counsel at O’Melveny & Myers LLP and former CFPB assistant deputy enforcement director, said in an email.

But with the CFPB’s coordination olive branch also comes a potential threat. The agency’s policy would potentially preempt states from bringing enforcement actions against companies for activities permitted by the sandbox or NAL program.

That section of the proposal has already caught the eye of the Conference of State Bank Supervisors. The states have had a cooperative relationship with the CFPB during both the Obama and the Trump administrations, but any provisions to grant companies immunity from state enforcement “could be a significant concern to us,” Conference of State Bank Supervisors Deputy General Counsel Margaret Liu told Bloomberg Law.

Potential Opposition

New York’s Department of Financial Services and the CSBS are already litigating other federal “innovation” policies that would preempt state jurisdiction. The suit between the states and the Office of the Comptroller of the Currency over a federal bank-like charter for fintech companies could be a preview of what could come for the CFPB and sandbox or NAL participants.

If state litigation does result, it could test the extent of the CFPB’s preemption authority under the 2010 Dodd-Frank Act.

Regulators in California and New York are expected to be hostile to the CFPB’s sandbox. “I would not suspect that they would back off whatever position they’ve taken toward fintech firms merely because one is admitted to the federal sandbox,” said Christopher Odinet, associate professor at the University of Oklahoma’s College of Law.

One wildcard is how the departure of New York Department of Financial Services Superintendent Maria Vullo in February will impact the state’s stance toward the CFPB’s policies.

Vullo has been one of the most vocal critics of the idea of regulatory sandboxes, but a successor could take a different stance. New York’s incoming attorney general, Letitia James, is another question mark on fintech issues such as regulatory sandboxes.

Adding Guardrails

Supporters of regulatory sandboxes say they hope the CFPB will use its authorities carefully, so that sandbox or NAL participation doesn’t just become a marketing gimmick or a perceived “seal of approval” by the CFPB.

The proposed policies would hand the CFPB powerful tools through exemptions and approvals that could help shape the future of the financial sector.

“Any kind of approval should be very carefully scrutinized internally and externally,” said Dan Quan, managing partner of Banks Street Advisory and the former director of the CFPB’s Project Catalyst, which in 2018 was changed to the Office of Innovation. Quan designed the first iteration of the CFPB’s no-action letter policy in 2016.

“The Bureau should lay out whatever protections are needed to ensure the new product and services that are being protected have real consumer benefits, and the guardrails in place to protect consumers,” Quan added.

UDAAP Worries

The threat of state enforcement could hang over one of the most significant changes to the CFPB’s no-action letter policy.

Industry groups criticized the older NAL policy for its lack of enforcement protections against unfair, deceptive or abusive acts or practices (UDAAP).

The new proposed policy makes UDAAP exemptions possible, but Quan said he suspects few companies will want to apply for an UDAAP-specific no-action letter. That’s because the CFPB isn’t the only one with UDAAP enforcement authority.

“You’re literally drawing a state target on your back,” for states to bring their own enforcement actions against a company under those provisions, Quan said.

Others say the UDAAP exemption is still critical. “Since UDAAP is highly subjective and discretionary, it’s one of the main sources of uncertainty that prevents innovation,” Jo Ann Barefoot, a former deputy comptroller of the currency and CEO at Barefoot Innovation Group, said by email.

“Knowing you have a safe harbor for the period of the experiment will unlock a lot of innovation by companies that believe their product will be superior for consumers, but worry about unpredictable interpretations,” she said.

To contact the reporter on this story: Lydia Beyoud in Washington at

To contact the editor responsible for this story: Michael Ferullo at