By Benjamin Roesch and Ben Kaufman | June 14, 2021
A key aspect of the business model for companies peddling income share agreements (ISAs) is reliance on what Federal Reserve Bank of St. Louis President James Bullard has called an attempt at “regulatory arbitrage . . . like Uber.” This phrase refers to the phenomenon of young companies increasingly—and sometimes knowingly—premising their business models on illegal conduct, then attempting to grow their startups so quickly that policymakers will hopefully become unlikely to hold these firms accountable. For companies in the ISA market, the illegal tactics involved in this concerning playbook include using deceptive marketing materials, building products premised on driving disparate outcomes for borrowers of color, and perhaps most importantly, claiming that ISAs are not “credit” or “loans” under federal and state consumer protection statutes. With the addition of ISA companies’ reliance on illegal prepayment penalties and widespread omission of legally required contractual language aimed at protecting borrowers from fraud, it is clear that the stakes for these firms’ apparent drive toward a claim of legal untouchability through sheer ubiquity are high. For borrowers, the stakes raised by the possibility of widespread harm are even higher.
The results of a new investigation published today by the SBPC illustrate yet another way that ISA providers have premised their business on illegal tactics, as well as the broad scope of legal liability that ripples out of these practices for ISA companies and their enablers. In particular, our analysis indicates that ISA providers’ failure to comply with state licensing and usury laws renders many of their contracts void and/or unenforceable. This finding has far-reaching consequences, as the ISA industry’s lawless conduct appears to involve a growing share of the student loan industry, including some of the biggest names of the student loan servicing system. Specifically, the servicing of ISAs has increasingly been contracted out to third-party student loan servicers such as MOHELA, Launch Servicing, and Scratch. Our analysis indicates that the servicing of void or unenforceable ISAs may amount to a violation of state servicing laws and both state and federal prohibitions on unfair and deceptive practices. Moreover, our analysis finds that state and federal law enforcement agencies such as the Consumer Financial Protection Bureau already have the capability to hold servicers accountable for servicing unenforceable debt—and to secure relief for borrowers.
Despite industry marketing to the contrary, there is little doubt that ISAs are loans for the purposes of state and federal law. As we have written before, that means that ISA providers have to comply with federal consumer protection statutes such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Consumer Financial Protection Act, and various other federal regulations. In addition, ISAs’ standing as loans also means that the product’s providers have to meet obligations under state laws such as state licensing requirements and usury limits.
Our investigation found that ISA providers are likely violating many of these state laws, often rendering the ISA products they have issued legally void. For example, out of a sample of prominent ISA companies, not one appeared to have secured any license to originate loans in any state. In many states, such as Minnesota and Virginia, consumer loans issued by unlicensed lenders are legally unenforceable. Further, our investigation found that ISA providers lend at interest rates that are likely to place their products in violation of many states’ usury limits. For example, while state usury caps for some varieties of consumer credit range as low as 8 percent, Hack Reactor and General Assembly offer ISAs whose APRs for the median projected student amount respectively to 22.8 and 23.5 percent. In states ranging from Arkansas to New York, loans with APRs that surpass relevant state interest rate caps are void under the law. Finally, our investigation noted that several schools that issue ISAs—such as Rithm School and Lambda School—have originated these products while operating without proper state regulatory approval as institutions of higher education. In California, where Rithm School and Lambda School are headquartered, state law renders unenforceable student loans that are made by schools operating without regulatory approval.
The consequences of these contracts’ unenforceability are far-reaching, setting up for liability both ISA providers and also the companies servicing these voided loans.
As our investigative memo discusses, the consequences of these contracts’ unenforceability are far-reaching, setting up for liability both ISA providers and also the companies servicing these voided loans. In particular, the companies collecting on unenforceable ISAs—a set of firms that may include both first-party ISA originators/servicers such as Leif and Vemo Education as well as third-party servicers such as MOHELA, Launch Servicing, and Scratch—appear to be breaking state and federal laws by continuing to demand that borrowers repay them.
For too long, startups flush with money from Silicon Valley and Wall Street have failed to understand that when it comes to student loans, the mantra of “move fast and break things” can produce a trail of shattered financial lives and massive liability for culpable companies. It’s time for law enforcement agencies at all levels to grasp the tools already at their disposal to halt the “uberization” of policymaking around student loans and protect borrowers from lawlessness masquerading as innovation.
Read more of the SBPC’s work on Income Share Agreements here, including our recent Emerging Risks symposium on ISAs and our investigations into ISA companies’ discriminatory, deceptive, abusive, and/or illegal practices.
Benjamin Roesch is a Senior Fellow at the Student Borrower Protection Center. He has significant experience in consumer finance and insurance issues.
Ben Kaufman is the Head of Investigations and a Senior Policy Advisor at the Student Borrower Protection Center. He joined SBPC from the Consumer Financial Protection Bureau where he worked as a Director’s Financial Analyst on issues related to student lending.