Fintechs Can Apply for Special Purpose Charter, but Should They?

The Office of the Comptroller of the Currency released a white paper in December outlining a proposal to extend special purpose national bank charters to fintech firms that provide similar services to traditional banks.

OCC currently offers special purpose national charters to financial institutions that receive deposits, pay checks (that includes payments made through debit cards or other electronic formats, which OCC called the "modern equivalent of paying checks" in its proposal) or lend money. The proposal would extend the regulations and privileges of a national charter to fintech firms that do the same.

The OCC has only issued six special purpose charters since 2012, "a reflection of the economy and consolidation in the industry," according to Brian Dolan, marketing director at law firm Pepper Hamilton.

Dolan moderated a webinar on Tuesday that explained what applying for such a charter would entail for a fintech firm, and what being approved for a charter would mean for its operations.

Some things to keep in mind regarding OCC's proposal: Fintech firms would not be required to seek a national charter to continue operations. They could continue offering their products and services in accordance with regulations in each state where they do business.

Fintechs with a special purpose charter would be subject to the same laws, regulations, and examination and reporting standards of national banks, as well as state laws that "only incidentally affect" national banks' ability to fulfil their federally sanctioned duties.

However, if a state law has a discriminatory effect on the fintech, or would prevent it from conducting business, the law would be preempted, according to Greg Rubis, special counsel in the financial services practice group at Pepper Hamilton.

A special purpose charter could ease some of the burden of following multiple state regulations, but there are other advantages, Rubis explained.

Firms with a charter could export interest rates from their home state, regardless of where they do business, Rubis said. For example, firms that establish Delaware or South Dakota as their home state could use those states' higher interest rates on loans regardless of where the loan originated.

"We should keep in mind we're talking about the home state. Unlike a corporation that can have its operations in New York but form under Delaware law, this statutory requirement is that you actually have your home base there," Rubis explained.

Applying for a Special Purpose Charter

The application process for a special purpose charter begins with a pre-filing meeting between the fintech firm and the OCC to describe the firm's three-year business plan, share information about the its leadership, identify any potential conflicts of interest, and discuss capital and subscription information. The pre-filing meeting is private, and there are no time limits after the meeting for the firm to file (or not) for a charter.

The actual application is about 17 pages, Rubis said, although he noted that banks that file for a charter find that once they've compiled all the information required, it's "substantially longer than that."

Firms have to publish a public notice that they're seeking a special purpose charter, Rubis said. "If there are a sufficient number of comments, or if the OCC decides this might be an area of public interest, it could even decide to hold a public meeting."

Firms have to file fingerprints of the leaders, IRS waiver forms and personal financial information along with the application. OCC is also looking for specific business plan and compensation information.

After the application is filed, OCC will conduct an investigation about the firm's current operations, chances of success, and how it will ensure it operates safely and promote financial inclusion and fair access, Rubis said.

'No Such Thing' as Fintech Charter

"There really is no such thing as an OCC fintech charter per se," according to Mark Dabertin, special counsel in the financial services practice group at Pepper Hamilton. Rather, the OCC is extending special purpose charters to fintechs.

"Under certain circumstances, [the OCC is] willing to accept charter applications from fintech companies including those companies that have limited activities," he explained, meaning the firm's activities are limited to certain products or services offerings, not that they're limited by law or regulation. The OCC is "imposing certain conditions on the approval of the charter, which makes those self-imposed conditions have the force of law."

"Unlike certain special purpose banks that are common today," he said, like trust or credit card banks, fintech firms approved for a special purpose charter "would not be recognized as having a Bank Holding Company Act exemption."

The Bank Holding Company Act applies to any entity that directly or indirectly controls at least 25% of a bank's voting securities, or can elect a majority of the board of directors. Banks that take insured deposits would automatically be subject to the act, as would those that make commercial loans, he said.

Credit card and trust banks are exempt thanks to the Competitive Equality Banking Act, which sets limits on activities those institutions can engage in. For example, special purpose credit card banks can't accept deposits under $100,000 and special purpose trust banks don't have access to the Federal Reserve discount window. Those exemptions wouldn't apply to fintech firms unless they "chose to become, say, a credit card bank, in which case they wouldn't need the OCC's proposal to do that."

Everything in a fintech firm's business plan could become a condition of approval for a special purpose charter, Dabertin said. That means that "if you want to make any significant deviation from that business plan, you're going to have to seek a no-objection approval from the OCC."

A common condition for approval for any bank, not just fintech firms, is the information security architecture, Dabertin said. The OCC could require a third-party review a firm's information security systems before approving its charter, he noted.

A contingency funding plan and diversification of risk will also be important factors in OCC's decision to approve a charter for a fintech firm.

Criticisms like those from Sens. Sherrod Brown, D-Ohio, and Jeffrey Merkley, D-Ore., that OCC doesn't have the authority to grant special purpose charters to fintechs are "baffling," he said.

"The OCC knows they don't have the authority to make new law. They can't create a new charter; Congress would have do that," he continued. "It really is just a regular national bank charter with imposed conditions, and there's nothing new or unique about that."

Out of concern over uninsured banks, which wouldn't be subject to laws like the Community Reinvestment Act, OCC discussed financial inclusion in its proposal.

"I'll be honest with you, we're not sure exactly what that means," Dabertin said. It might mean fintechs will be required to make their products and services available to all consumers without discrimination, or require them to invest in entities that reach financially disadvantaged consumers, he suggested.

"Our position would be that if the bank is not accepting deposits and not taking funds from a community, that it shouldn't have CRA-like requirements," Dabertin said.

— Read When it Comes to Financial Literacy, Fintech Is Dropping the Ball on ThinkAdvisor.