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State challenges to fintech charters a losing battle so far

Legal experts ask if latest loss could prove decisive

The U.S. Court of Appeals for the 2nd Circuit tossed out a New York state financial regulator’s lawsuit challenging a federal decision to grant special types of national bank charters to fintech firms.
The U.S. Court of Appeals for the 2nd Circuit tossed out a New York state financial regulator’s lawsuit challenging a federal decision to grant special types of national bank charters to fintech firms. (Erik McGregor/Lightrocket via Getty Images file photo)

State regulators have hit a major obstacle in their yearslong fight against federal regulators seeking to grant national bank licenses to financial technology firms, according to legal experts tracking the effort to launch a new era in banking.

The U.S. Court of Appeals for the 2nd Circuit on June 3 tossed out a New York state financial regulator’s lawsuit challenging a decision by the federal Office of the Comptroller of the Currency to grant special types of national bank charters to limited-purpose fintech firms.

Lawyers following the case are asking whether the decision marks only the latest losing round in the states’ ongoing bout or a more decisive victory for the federal oversight of fintech.                                    

The appellate court dismissed a suit by the New York Department of Financial Services superintendent, who sought to block the OCC from issuing the charters. The Comptroller’s Office is taking applications for fintech companies that say they are in the “business of banking” — as the term is used in the National Bank Act — but don’t take deposits.

The court said the New York DFS didn’t have standing to move ahead with a lawsuit because it failed to allege the comptroller’s decision caused it to suffer an actual or imminent injury. As a result, the court said, its claims are premature, or “unripe,” under the Constitution.

New York’s financial services superintendent had claimed there was a substantial risk the OCC would enable limited-purpose fintechs with special charters to escape the state’s regulatory jurisdiction by claiming federal law preempted state law.

But, the 2nd Circuit observed, no nondepository fintech has yet applied for such a charter, meaning no state law or regulation has been preempted, according to a June 7 analysis of the decision by lawyer Jeremy T. Rosenblum. He is co-leader of Ballard Spahr LLP’s consumer financial services practice and a co-chief of the firm’s fintech industry group.

“At least until a non-depository fintech that DFS currently regulates — or would otherwise regulate — decides to apply for” a special-purpose national bank charter, any alleged loss or injury to New York regulatory agency will remain purely “conjectural or hypothetical,” rather than “imminent” as the Constitution requires, the court wrote.

The appellate decision reversed a lower court ruling that in 2019 held New York’s claims were timely. The U.S. District Court for the Southern District of New York had also ruled the OCC exceeded its authority in deciding to accept the fintech special-purpose applications because the National Bank Act “unambiguously” requires national banks to accept deposits.

Rosenblum called the lower court’s ruling “clearly incorrect.”

The lawsuit’s dismissal is the most recent setback for state regulators looking to preserve their primacy in the oversight and supervision of fintech companies operating within their jurisdictions. Currently, fintechs that offer certain products or services are required to be licensed and regulated by each state in which they transact business.

“Obtaining a ‘FinTech Charter’ from the OCC would leave companies with one federal regulator,” lawyer Stephen A. Aschettino, a partner in the New York office of the international law firm Reed Smith LLP, wrote in a client notice. He said the appellate court’s decision “effectively brought to an end” New York’s efforts to block national fintech charters.

Years of state resistance 

State financial regulators have been fighting the battle for years.

In December 2017, another judge in New York’s Southern District dismissed the state Financial Services Department’s first lawsuit against the OCC, also for lack of standing and ripeness.

The U.S. District Court for the District of Columbia has dismissed as premature two nearly identical lawsuits — one in 2018 and the other in 2019 — filed by the Conference of State Bank Supervisors challenging the OCC’s authority to grant the special fintech licenses.

The CSBS, which in January launched a third lawsuit in D.C. against the OCC, said the dismissal of the New York suit was a “disappointing development” but vowed to push forward with its own litigation. The OCC last month moved to have the third lawsuit dismissed for lack of standing and ripeness; the motion is pending before the court.

CSBS Executive Vice President Margaret Liu noted the 2nd Circuit didn’t dismiss New York’s case “on the merits,” meaning the judges didn’t decide whether or not the OCC actually has the authority to grant the national charters — only that it was too early to litigate the case.

Last week, the D.C. federal district court hearing the CSBS’ complaint entered an order temporarily staying the lawsuit. CSBS filed a motion to stay the case, noting that acting Comptroller Michael J. Hsu indicated to the House Financial Services Committee last month that the OCC under the Biden administration was currently reviewing the agency’s national bank chartering policies.

Norman H. Roos, senior counsel at the firm Robinson & Cole LLP, told CQ Roll Call that it appears the 2nd Circuit took “a somewhat moderate middle-of-the-road approach” by rejecting New York’s claims on “procedural grounds,” but “left the door open for the agency to reassert its claims at a later date.”

Rosenblum said the 2nd Circuit’s decision left him and his team at Ballard Spahr “disappointed but not surprised” that the court didn’t reach a decision on the merits of the case. “Our sole real criticism is that the Second Circuit did not formally vacate the erroneous lower court decision,” he wrote.

Rosenblum said his firm is confident the appeals court would uphold the OCC’s national fintech chartering authority if the judges were to consider the substantive, rather than procedural, issues involved.

Sanford M. Brown, a partner in the Dallas office of law firm Alston & Bird LLP, called the 2nd Circuit’s decision “well-reasoned” and “thoroughly vetted.” He said he thought the New York suit was premature, although it raised reasonable good-faith questions.

Brown told CQ Roll Call he doesn’t think the latest appellate decision marks an end to the controversy.

“I doubt this is the last we’ve heard from the state bank regulators on the subject,” he said.

Brown said he’s not confident Congress, in the current political environment, will settle the issue anytime soon by clarifying the National Bank Act or passing some other legislation.

“It won’t surprise me one bit if this is an issue that gets decided by the U.S. Supreme Court,” he said.

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