The Consumer Financial Protection Bureau (the “Bureau”) issued its first no-action letter (“NAL”) to Upstart Network, Inc. (“Upstart”), a marketplace lender that sought to clarify that its automated model for underwriting unsecured, non-revolving loans does not present a violation of the Equal Credit Opportunity Act (“ECOA”) and its implementing regulation, Regulation B. The NAL signifies the Bureau—acting through the “Bureau staff” in a manner distinct from other forms of official action—has no present intent to initiate supervisory or enforcement action against Upstart with respect to the ECOA.
In its request for a no-action letter, Upstart acknowledged that its credit underwriting model—which involves proprietary applications of artificial intelligence and machine learning to supplement traditional credit scoring techniques—“must avoid unlawful disparate impact, or statistical bias, that would be harmful to disadvantaged groups.” By affording no-action treatment to Upstart, the Bureau may promote innovation in this key market for unsecured, non-revolving loans and provide Upstart the ability to access growth capital and continue online advertising for its loan products. But no-action comes at the price of substantial oversight. For at least the next three years before the NAL’s sunset, Upstart commits to deliver key reports and compliance metrics to the Bureau in a manner that permits oversight of Upstart’s use of emerging technologies for underwriting, and impliedly submits to the exercise of some degree of the Bureau’s oversight over other aspects of the company’s credit operations for consumers.
Since we have been tracking the Bureau’s actions in this area, particularly with our October 2014 analysis of the agency’s proposal for a NAL policy, we offer background on the Bureau’s NAL policy statement and provide key takeaways from the staff’s no-action treatment for Upstart.
Background on the Bureau’s NAL Policy
When the Bureau adopted its final policy statement for issuing no-action letters (“NAL Policy”), its stated purpose was to add another “tool in the Bureau’s kit to facilitate compliance and innovation.” Under the NAL Policy, a person can apply for no action treatment on a new product or service that offers the potential for significant consumer benefit where there is uncertainty about how specific provisions of law would be applied by the Bureau. The NAL advises an applicant that the staff of the Bureau does not plan to recommend initiation of an enforcement or supervisory action with respect to the specific matter described in the application. The Bureau’s Project Catalyst, a program designed to encourage consumer-friendly innovation in markets for consumer financial products and services, facilitates the NAL program as part of its work to support marketplace innovation.
The Bureau has taken a range of actions, typical for a banking agency, to provide guidance to industry regarding compliance with federal consumer financial laws, such as adopting rules, official interpretations, and settling (or taking to judgment) enforcement actions. The Bureau’s actions generally apply to a wide array of persons and typically are adopted through a notice-and-comment procedure or adjudication under the Administrative Procedure Act (APA). As a supplement to these customary tools, the Bureau’s NAL Policy is designed to focus on one person’s particular consumer financial product or service, or a feature of that product or service. Specifically, a NAL results in a recommendation that an enforcement or supervisory action should not be initiated against that person. Among the desired virtues of the targeted action of a NAL are its specificity and a “wait and see” quality: withholding overall judgment until more information becomes available—information about the potential markets for the product or service, the possible benefits for consumers, the potential regulatory implications, etc.—is a posture in line with innovation.
However, unlike an adjudication under the APA, the Bureau has structured the NAL to avoid binding the Bureau, including for the precise subject of the NAL itself. As we had anticipated in 2014, among the drawbacks of the NAL Policy is the discretion of the staff, stated in Section D.6 of the NAL Policy, to modify or revoke a NAL “at any time” and “for any reason,” which modification or revocation only is “intend[ed]” to be issued in writing. Plus, Section D.9 of the NAL Policy describes the potential of “retrospective enforcement.” For example, if a person who had obtained no-action treatment acts in a manner inconsistent with one or more of its commitments for conduct after issuance of the NAL, the Bureau’s staff may recommend that an enforcement action reach back to conduct that occurred prior to the issuance of that NAL— including that which would otherwise have been covered by the NAL.
Moreover, the Bureau has aimed for NALs to be issued to a select few—“one to three actionable applications per year”—in part because one of the stated objectives of the NAL Policy is to concentrate the Bureau’s resources on other regulatory areas. In this regard, the Bureau rejected comments recommending extending the principles of the NAL Policy to established financial products or services: “If a product already is established in the marketplace, or if there are no substantial regulatory uncertainties interfering with its development, then Bureau resources for reducing barriers to innovation would be better allocated to other NAL cases, or to other efforts.” Section C.8 of the NAL Policy reflects this position by requiring a requesting person to describe in its application the “extent to which the request is sufficiently limited in time, volume of transactions, or otherwise, to allow the Bureau to learn about the product and the aspects in question while minimizing any consumer risk.”
Key Takeaways from the NAL to Upstart
First and foremost, the NAL to Upstart represents only the current assessment of the staff of the Bureau and in no sense constitutes an official statement of the CFPB’s policy under ECOA or Regulation B. For the reasons described above, the NAL could enable Upstart’s underwriting model to more fully develop if, for example, the company’s proprietary approach for combining traditional and non-traditional credit scoring data to model credit decisions and pricing for unsecured loans produce a disparate impact on consumers that constitutes a violation of Regulation B. But we believe that’s the starting point to appreciate the limits of the NAL Policy because the NAL does not clearly explain why Upstart’s underwriting model does not present an actionable issue under Regulation B, or the nature of the changes in the company’s model that could alter this conclusion.
Persons encountering substantial regulatory uncertainty under one or more federal consumer financial laws, when developing novel financial products or services should take into account the slender reed of benefits that the NAL Policy provides. The following highlights the key benefits and costs in the context of the no-action treatment for Upstart.
- Slack in the Standard for Whether the Product or Service Is “Established in the Marketplace”: Even though the Bureau had announced when adopting the NAL Policy that a NAL would not be issued for “established financial products or services” (emphasis added), the Bureau now appears to be prepared to relax that constraint. Certain provisions of Upstart’s Request for a No-Action Letter (undated) suggest that the request was submitted in late 2016 or early 2017, and by that time Upstart had been operating its marketplace platform for at least two years. In addition, Section (2)(a)(II) of Upstart’s Request for a No-Action Letter, states: “So far, over 80,000 loans totaling over $1 billion have been originated through Upstart’s platform . . . .”
- Uncertainty on Timing to Obtain a NAL: The date on which Upstart initiated discussions with the Bureau, or submitted its NAL request, is not disclosed, and there does not appear to be an easy mechanism to gauge how many persons have filed requests. Apart from formal requests, there is no way to measure how many persons have arranged for “informal preliminary discussion[s] in advance of filing [applications for NALs].” Still one bit of information is clear: in the 18 months since the NAL Policy was adopted, only one NAL has been issued.
- No Substantive Comment on the Federal Consumer Financial Law: Item (6)(b) of Upstart’s request plainly describes the need for a NAL: “Upstart’s underwriting methodology should not be precluded by ECOA’s prohibition of credit practices that result in disparate impact. Based on analysis to date, and as reflected in confidential information provided to the Bureau, Upstart believes that its underwriting methodology has not produced a disparate impact on protected classes in violation of ECOA or Regulation B.” The NAL makes no mention of “disparate impact” that could give any guidance—either to Upstart or to another person—about conduct by a creditor or its service provider that could be proscribed by Regulation B.
- Substantial Benefits to Consumers Is a Real Criterion: Section C.2 of the NAL Policy requires a person to describe in a request “the extent to which evidence, including the requester’s own testing, indicates that the product’s aspects in question may provide substantial benefits to consumers.” In light of its success (unique, so far), Upstart’s NAL request will inevitably serve as a template for future applications on similar issues, and in this regard Upstart’s detailed account of the alleged benefits of Upstart’s underwriting model (set forth in item (4)) appears to establish a baseline for the kind and scope of the “evidence” the Bureau’s staff will expect in order to issue a NAL.
- Supervision as a Condition for a NAL: One could easily infer that Upstart’s “own” request to the Bureau was highly negotiated. In its application for a NAL, Upstart—a non-depository person that does not appear to fit any of the categories that could give rise to the Bureau’s supervisory authorities under 12 U.S.C. § 5514(a)(1)—ceded reporting duties to the Bureau that generally correspond to supervisory functions, including:
- Committing to sharing the “results of Upstart’s fair lending and access-to-credit test results” (item 9);
- Promptly notifying the Bureau if Upstart is investigated, reviewed, or the object of an enforcement action by a government authority or the object of a “private civil action” (item 11); and
- “[N]otify[ing] the Bureau before new variables are considered eligible for use in production” in Upstart’s underwriting model (item 14).
Taken together, the no-action treatment afforded by the Bureau for ECOA and Regulation B involves plenty of ongoing, informal supervisory actions by the Bureau that could well influence the pace and manner in which Upstart is able to innovate. Persons considering applying for no-action treatment should weigh carefully the downside risk of bringing to the Bureau’s attention through the application process a practice or product of potential compliance concern, especially in light of the small number of NALs to be issued each year. Other potential applicants for a NAL also will need to balance the constraints imposed by a successful NAL against the risks of proceeding without any Bureau assurances of no-action.
 Policy on No-Action Letters, 81 Fed. Reg. 8,686, 8,688 (Feb. 22, 2016).
 81 Fed. Reg. at 8,691.
 However, one vital provision of the federal consumer financial laws over which the Bureau has authority is the prohibition against an unfair, deceptive, or abusive act or practice (12 U.S.C. § 5531 (2015) (“UDAAP”)). Even though the NAL Policy is silent as to whether a NAL could be issued for a request covering an ambiguity regarding an unfair, deceptive, or abusive act or practice, the Bureau has concluded that “UDAAP-focused NALs will be particularly uncommon.” 81 Fed. Reg. at 8,689.