What’s in Your Wallet?

Are digital wallets prepaid accounts? A federal regulator says yes. PayPal just said no. Much is riding on who’s right.

Time was, it was pretty clear how to tell a prepaid account. Almost always, it consisted of an account held by a bank or merchant and funded by somebody who then accessed the money using a plastic card. Nowadays, though, things aren’t quite so clear. What’s muddying things is the concept of the digital wallet.

These wallets aren’t all that new. Companies like PayPal Holdings Inc. have been issuing them for years. But last spring a federal regulator, the Consumer Financial Protection Bureau, put into effect a regulation that governs what issuers must and must not do with prepaid accounts—and that regulation doesn’t stop with plastic cards linked to funded accounts.

In a move that could affect a wide range of companies not typically thought of as purveyors of prepaid accounts, the CFPB has aimed its rule at digital wallets, as well. And last month, one of those purveyors fired back.

PayPal sued the CFPB alleging its prepaid rule represents a “category error” and a violation of the First Amendment and should be vacated by the court. The lawsuit, filed in the U.S. District Court for the District of Columbia, charges that the rule forces PayPal to make awkward and confusing disclosures to consumers by improperly including digital wallets under its definition of a general purpose reloadable (GPR) card.

“[T]he Bureau’s onerous compulsory disclosures require PayPal to prominently feature items that are irrelevant to the core use of its digital wallet offering, such as ‘periodic,’ ‘per purchase,’ ‘customer service,’ and ‘inactivity’ fees,” PayPal’s suit alleges.

By forcing speech in this way, the rule violates the U.S. Constitution’s free-speech protections, says PayPal’s complaint. “[T]he Prepaid Rule is invalid, and may not be enforced against PayPal, because it violates the First Amendment of the U.S. Constitution,” the suit alleges.

PayPal further charges that, when the regulation was still a proposal under consideration and open for comment, the CFPB brushed aside the company’s argument that digital wallets, which represent its core product, are fundamentally distinct from prepaid card products.

“Contrary to its mission of protecting U.S. consumers … the CFPB unreasonably dismissed PayPal’s evidence and finalized a Rule that treats identically GPR cards and PayPal’s very different digital wallet products,” the filing alleges.

‘Ripple Effects’

PayPal’s suit isn’t the first to challenge the CFPB on constitutional grounds. Last year, the U.S. Supreme Court agreed to take up a case that argues the agency is unconstitutional because of its model of governance by a single director rather than by a commission.

But PayPal’s case could have wide implications for the payments industry, touching on issues of how to define a prepaid account and how to manage increasingly popular mobile wallets. “It’s really important to watch this,” says Patricia Hewitt, principal at PG Research & Advisory Services, a Savannah, Ga.-based consultancy.

“It could have ripple effects across the industry,” adds Ben Jackson, chief operating officer at the Washington, DC.-based Innovative Payments Association. “They’re challenging the big picture on regulation—how much can be regulated, how much statutory authority do you need?”

However the case is ultimately decided, he says, “all of the mobile wallets will be affected by this. Apple Pay and all of those guys will pay close attention.”

At the heart of the case is the question of just what a digital wallet holds and how common that holding is. PayPal argues the majority of its wallet holders simply store payment credentials—in other words, other accounts they may use for payments. These holders are not storing funds for future use.

“I think they have a good argument,” argues Anita Boomstein, an attorney at New York City-based Manatt, Phelps & Phillips LLP who advises on payments matters. “Is it reasonable to include an account that holds credentials in the vast majority of cases in the broad sweep of what’s a prepaid account?” Boomstein is not connected to PayPal’s suit. The lead attorney representing PayPal did not respond to a request for comment for this story.

But that argument doesn’t wash with all observers. “PayPal is trying to have it both ways. They’re trying to say they’re a wallet but also a funding source,” says Aaron McPherson, vice president of research operations at Mercator Advisory Group, Marlborough, Mass.

PayPal’s free-speech argument—that the rule forces it to make disclosures that don’t apply or that confuse users—also doesn’t wash with McPherson. “We have a hard time seeing how a First Amendment claim would prevail at the district court,” he says. “Restraint of trade would be a more effective argument.”

Live With It

PayPal’s case represents what is probably the most serious challenge to the prepaid rule since it took effect after years of delay. Created by the Obama Administration in the wake of the 2008-09 financial crisis, the CFPB considered prepaid regulation for years before releasing the first version of its rule in January 2017. The rule then underwent three revisions and two extensions of its effective date before finally taking effect in April 2019.

Now that PayPal has literally made a federal case out of the rule, it would be a mistake to expect resolution any time soon. Says Jackson: “The reality is this is going to take a long time to play out. People are going to have to live with the rule in the meantime.”