Regulatory Landscape Remains ‘Uncertain” in Factoring Industry

Even with a recent win on the regulatory front, the factoring industry and commercial finance sector overall need to remain vigilant of an increasingly uncertain future when it comes to disclosure legislation, especially at the state level. Commercial Factor spoke with Brett Ashton, a partner and chair of the financial institutions practice at Krieg DeVault, to explore the many recent developments in the regulatory landscape.

If you had to pick one word to describe the state of regulations in the commercial finance sector right now, what would it be and why?

Brett Ashton: “Uncertain” — in large part because the industry really doesn’t have a clear sense as to what their regulatory burden will be in the coming years. Hopefully the coming 12 to 18 months will bring some degree of consistency in how states approach these issues. While I’d like to think the Consumer Financial Protection Bureau’s decision to exclude factors from the 1071 rule will help move factors out of the focus of these new laws, time will tell.

A California district court recently approved the continuation of a lawsuit against the California Department of Financial Protection and Innovation in relation to the state’s disclosure laws. What do you think this decision portends for regulations in California and for the country overall?

Ashton: I expect the California litigation to continue for some time because both sides feel they can’t back away from their respective positions. However, until/unless that case is resolved in favor of the industry, the regulation will continue to be in place. I expect the more state laws and regulations similar to California and New York that we see in the coming years, the more we will see legal challenges like this.

In February, the New York Department of Financial Services finalized its regulations. What were some of the most important takeaways from the final rule?

Ashton: I think the most significant takeaway from the final rule was its reach. The definition of “commercial financing” alone (including, among other things, “other forms of financing”) should put anyone in the commercial lending industry that is not affiliated with a depository institution on notice that regulation could be coming their way next. Also, the need for transaction specific disclosures that comply with the exact letter of the regulation down to the size and type of font used was also eyebrow-raising.

What are some of the most important nuances of correctly disclosing factoring transactions under California and New York’s regulations, as well as other states?

Ashton: First and foremost, the correct calculation of APR, and the use of the precise size and style of font in your disclosures. Details really matter in these types of disclosures, and it’s critical that lenders follow the exact requirements of the regulation.

How are recently enacted regulations in states like Utah and Virginia different and/or the same as those from California and New York?

Ashton: Thankfully the requirements under Utah and Virginia laws are generally narrower in scope than the regulations enacted in California and New York.  While Utah’s law still impacts factors (and has licensing requirements like those in California), the disclosure requirements are significantly less than those seen in California and New York. Further, the number of transactions exempted from the scope of the Utah law is much broader than that in California and New York, with purchase money obligations, leases and commercial loans over $1 million excluded from the scope of the rule. Virginia’s law applies to sales-based finance transactions and merchant cash advances.

We’ve also seen a recent wave of other states proposing their own commercial finance disclosure laws, specifically Maryland and Texas. Which states do you think could join next and how can factors do to prepare themselves?

Ashton: I’ll defer to the IFA lobbyists on this question as to where this trend spreads to next. I will say that I expect we will see efforts in a majority of states in the coming years to adopt some form of what is currently in place in California and New York. I know, for example, that Illinois considered a very similar proposal this year.

As for how factors can prepare themselves, adapting to the stringent requirements of the California and New York regulations will prepare you well for what other states may elect to do in the future. While uniformity of state law is far from certain, on lending issues, historically, New York and California lending laws tend to be more comprehensive than most. So if you can comply with California and New York, odds are you’ll be equipped to be compliant with other state laws, even if they may be somewhat different.

On a national level, the Consumer Financial Protection Bureau finalized the rule to implement Section 1071 of Dodd-Frank at the end of March and factoring firms were not covered in the rules. Do you think this could have any impact on how regulators treat factors under disclosure laws at the state level? Why or why not?

Ashton: I hope state regulators will take note of the bureau’s decision to exclude factors from the final 1071 rule, but I fear that now that California and New York have included them, other states may elect to follow suit. Much of how this plays out will depend on how the various state regulators perceive the exclusion of factors from the final 1071 rule, i.e., did the bureau only exclude factors from the 1071 rule because they knew they couldn’t support including it based on the scope of Reg. B? Certainly, the CFPB felt there were certain “ancillary” transactions to factoring that should be covered. If state regulators feel they can’t, or don’t want to, parse the different types of transactions similar to factoring transactions, then they may not give the bureau’s decision to exclude factors from the final 1071 rule much weight.

Anything else you’d like to add?

One final point that I think factors should consider: Many of these new laws require a license from the factor to continue operations. With the license comes an annual license renewal and often an annual examination. This ongoing supervisory oversight is an issue that the industry should take seriously. Depending on the extent of state law requirements, state examination can become challenging for licensees.

For more insights from Ashton on the state of regulation in the factoring industry, make sure to check out the recording of his recent webinar for the IFA on the topic.