Why FinTech Needs Boston Blackie

Many years ago, in the 1940s, there was a series of B movies about a private eye named Boston Blackie, a former jewel thief turned investigator. Those movies were followed (1951-1953) by a weekly television show featuring the same actor, Chester Morris, in the title role. That TV show was regularly watched by your author. Boston Blackie was an enemy of criminals and, famously, “a friend to those who have no friends.” The budding FinTech industry today might well feel a sympathetic longing for a champion like Boston Blackie to afford it appropriate recognition, especially when it comes to raising capital.

The Banking Industry

On Patriots’ Day, September 11, 2020, the U.S. Securities and Exchange Commission (“SEC”) issued a final rule amending the disclosure requirements for bank holding companies, banks, savings and loan holding companies, and savings and loan associations. This new rule will replace the SEC’s disclosure “guidance” set out in Guide 3, first promulgated in 1976 along with a series of other industry-specific disclosure Guides. Despite material evolutions in the American financial industry, including banking institutions, over the last 34 years, Guide 3 was last substantially revised in 1986. Accordingly, the very careful and detailed approach taken in the new rule is almost certainly welcome to the capital market participants dealing with the covered banking institutions. The new rule becomes effective on November 16, 2020, BUT compliance is required only for banking institutions whose fiscal year-end is after  December 15, 2021. Guide 3 will remain in place until January 1, 2023, giving the covered institutions an extended transition period.

In some ways, more surprising and troubling about this major SEC “housekeeping” effort is what the new rule does NOT cover. Ever since the heady days of financial conglomerates (e.g., Sears and Dean Witter, also known as “Socks and Stocks;” and Citigroup, which at one time included a major insurance company, a major investment banking house, and, perhaps, the leading U.S. commodities trading firm), which blurred the lines established by the 1933 Glass-Steagall Act, and were in turn redrawn by the 1999 Gramm-Leach-Bliley Act, only to face recalibration in the Dodd-Frank Act of 2010, it has become increasingly clear that finance is more than, AND depends on more than, banking institutions. Moreover, as recently reported in the financial press, since the 2007-2008 Great Recession banks have significantly withdrawn as the primary source of mortgage funds. Yet, we know that mortgage financing is critical for home buying, the primary route for building wealth for Americans. It turns out that the withdrawal of the banks opened opportunities for non-bank lenders, and again as reported in the press, those non-bank lenders supplied 59% of mortgage funds in 2019. The development of non-bank lenders has paralleled that growth in fields beyond mortgage financing, involving loans to individuals and to businesses. Many of these non-bank lenders rely on digital technology both to make (including underwriting using algorithms) and to administer loans.

The FinTech Industry

Insurance companies, which are subject to very substantial regulation by state regulators, are not covered by the SEC’s new rule, despite the importance of the roles played by insurance companies in financing activities. But perhaps even more odd, the SEC’s new rule does not address non-bank lenders, especially so-called FinTech entities. Yet, it is a matter of common knowledge that the non-bank lenders (even those which, like Rocket Mortgage, have gone public) almost never have their own capital resources. Rather non-bank lenders rely on lines of credit from banking institutions. So in effect, the non-bank lenders have become major “sales agents” for banks. One would have thought that the SEC, in the course of modernizing the disclosure regime applicable to financial market participants, could have recognized these developments and designed the new rule to include FinTech entities.

This shortcoming is all the more noticeable because federal banking regulators have very expressly made rule changes and/or clarifications designed to facilitate the growth of the FinTech industry. In April 2019, the Board of Governors of the Federal Reserve System (“Fed”) initiated rule clarifications as to what constitutes “control,” so that (with a clearer line) banks would be better able to invest in FinTech entities without causing the entities to be subject to the Fed jurisdiction. See my blog “'Control' – Objective and Subjective: The Jurisdiction of the Federal Reserve and FinTech Investments.” Then on October 27, 2020, the Comptroller of the Currency (“OCC”) issued the so-called “True Lender Rule,” which effectively (so long as substantive conditions are met) allows a national bank (the OCC regulates national banks) to enter into a partnership with non-bank lenders. This industry development, although facing challenges from some states concerned about lending practices, greatly facilitates the potential growth capacity of FinTech entities.

So, why is it the SEC seems unaware of these developments? Surely, the FinTech entities would welcome a Boston Blackie-like “friend” at the Commission. If you have any questions about this post or any other related matters, please feel free to contact me at pdhutcheon@norris-law.com.