Cover Story: States’ Rights

Critics say state-by-state money-transfer licenses deter payments startups and entrench incumbents. Defenders say they protect the public. What’s really going on?

By Jim Daly

Christopher Ferro, who heads up legal and compliance operations at digital wire-transfer company Xoom Corp., was pleased. It was Sept. 5, and he had just opened up the day’s mail, which included an envelope from the state of Vermont. In that envelope was something significant—the last state money-transfer license Xoom needed to serve the entire United States.

“I’ve lived through enough licenses,” Ferro says. “It’s a lot of years.”

Xoom has been accumulating state licenses since it opened its doors in 2001, and Ferro has been involved in licensing issues since he joined the San Francisco-based company five years ago. Vermont isn’t a big state, but 47 states—all but Montana, New Mexico and South Carolina—now require companies that move money around to get a license if they want to do business in that state.

Not surprisingly, money-transfer companies prize licenses from the most populous states because of their potential customer bases, but licenses from such states can be harder to obtain than those from smaller states.

Meracord LLC, a payment processor based in Tacoma, Wash., held a staff party in June 2012 when it obtained its California money-transmitter license.

“It was our 41st license,” says chief executive Linda Remsberg, noting that the licensing process took a year. “We had a big celebration around here because that was a difficult one to get.”

But parallel developments in fast-changing payments technology and heightened scrutiny by state regulators have raised questions that are raging through the payments industry in 2013: Are state money-transmitter licenses stifling payments innovation? Is the duplicative and expensive process of getting state licenses creating barriers to entry for startup companies, many of which are thinly capitalized, and protecting incumbents?

Or, is licensing the price that must be paid to protect consumers from those who would take their money and run?

‘Absolutely an Impediment’

The answer from many inside the payments industry and those who follow it closely is that yes, the state licensing process erects too many barriers to firms that want to provide money-transfer services.

“It’s time-consuming, it’s expensive,” says Arkady Fridman, a senior analyst at Boston-based research firm Aite Group LLC and former PayPal Inc. executive. “It absolutely becomes an impediment.”

How expensive? Fridman says one license can cost up to $500,000, depending on the state and how extensive its licensing process is. Remsberg says her company spent just over $10 million to get its first 41 licenses, which works out to about $244,000 per license, and it’s taken five years.

The biggest losers in such a gauntlet are likely to be small companies that don’t have the financial and personnel resources to jump through dozens of licensing hoops.

Some frustrated companies reportedly are migrating to other countries. And one entrepreneur, Aaron Greenspan, founder of the Palo Alto, Calif.-based startup Think Computer Corp. with its FaceCash payments service, is suing the state of California over its money-transmitter law.

The licensing issue is generating more debate in the payments industry because over the past couple of decades, more and more states have begun requiring them. Indiana is one of the most recent additions, for example. A money transmitter also needs licenses to do business in the District of Columbia and Puerto Rico.

And some states with longstanding requirements have made them tougher. In January 2011, California changed its law so that any company in the world, no matter where it was based, needed a California license if it wanted to serve customers in the nation’s most populous state, according to David Landsman, executive director of the National Money Transmitters Association (NMTA), a trade group based in Great Neck, N.Y.

The law also combined the previous categories of transmitters of money abroad, issuer of payment instruments, and issuer of travelers checks into the single category of money transmitter.

Meanwhile, technology has vastly changed the payments industry, enabling countless startups, including Xoom, Meracord, and Square Inc., to gain a foothold. Some new companies have already encountered trouble with state authorities over money-transmitter licensing.

In January, the Illinois Department of Financial and Professional Regulation issued cease-and-desist orders against mobile-payments processor Square and NetSpend Holdings Inc., a prepaid card program manager now owned by Total System Services Inc., saying they did not have the requisite state money-transmitter licenses.

San Francisco-based Square ran into more trouble down in Florida, where the Office of Financial Regulation fined it $507,000 in July for operating in the state for more than two years without a license. Florida issued Square its license after the company paid the fine without admitting a violation, according to press reports.

Square says it is awaiting money-transmitter licenses in only three states, which it did not identify. The company has continued to operate in Illinois during its licensing difficulties there.

The company told Digital Transactions that it could not say much about the Florida and Illinois incidents apart from stating that it resolved the Florida issue and is working with Illinois regulators to address their concerns.

An emerging market, or battleground, depending on your point of view, for state licensing is virtual currency such as Bitcoin that exists outside the control of central banks or other financial regulators. In August, the New York State Department of Financial Services (DFS) announced an inquiry into virtual currencies.

“We are concerned that—at a minimum—virtual-currency exchangers may be engaging in money transmission as defined in New York law, which is an activity that is licensed and regulated by DFS,” says a letter from Benjamin M. Lawsky, New York’s superintendent of financial services.

‘A Fragmented Market’

How many transmitters are licensed by states is difficult to ascertain. The NMTA does not have a running total. The U.S. Treasury Department’s Financial Crimes Enforcement Network, or FinCen, says the U.S. had 35,348 registered money-services businesses as of Sept. 13.

That figure, however, includes the many money transmitters with common ownership and brand usage, and such entities as check cashers, currency exchanges, money-order sellers, and related businesses.

In contrast, California had only 71 licensed money transmitters at the end of 2012, an increase of 16 since 2011.

While the money-transfer business has some well-known names, it is not overly concentrated. The two leading U.S.-based players, The Western Union Co., the world’s biggest money transmitter, and MoneyGram International Inc., No. 3 globally, collectively handled just 21% of global transmitter payments in 2011, according to a 2012 Aite report.

“It’s a very fragmented market,” says Fridman. “There are going to be some providers that are not going to be able to comply, or they don’t want to comply” with state licensing regulations. “Some are going to close up shop.”

Licensing requirements vary by state, but the approval process often includes background checks on the company owner and its major officers, minimum equity levels and bonding, adequate staffing to assure compliance with the law, and other conditions. 

Like many aspects of the payments industry, however, the issue of state licenses can become highly nuanced, even maddeningly complex, upon closer examination. Even industry executives and staunch critics of state-by-state licensing agree that states have a legitimate interest in ensuring that consumers who take cash to a money transmitter and expect it to be sent by wire or other electronic form to relatives or friends in other states or countries do not become victims of theft and fraud.

“First and foremost, people are coming to you and handing you money and leaving—and trusting you to do the right thing with their money,” says Ferro.

That time-honored rationale for regulation has been joined by new forces since the turn of the 21st Century, namely, governmental concern about thwarting the financing of terrorists and drug cartels, and the rise of Internet-based technology that has changed the face of the payments and many other industries.

“It’s one of those regulatory requirements that has changed over time,” says Meracord’s Remsberg, who founded her company as a provider of payment-related services in the real-estate sector. She later switched to accumulating money-transmitter licenses and providing compliance and processing services to other payments companies, and built her own application programming interface (API). As such, Meracord will stand in for a company that needs a license to operate in a particular state.

Five Years in Jail

Fighting terrorism and drug lords who transfer money to and from other countries has been mainly the province of the federal government, which does not license money transmitters as states do. Where states leave off and the federal government begins, however, isn’t always so clear.

Money transmitters have to comply with certain anti-money-laundering and other mandates from FinCen, for example. They must file so-called suspicious-activity reports when they believe something about a transaction may be legally questionable, though it is largely up to the transmitter to decide what’s suspicious. They also have to file reports with the Treasury for transactions of $10,000 or more.

“If you wake up one day and you decide you’re a money transmitter, you must register with FinCen,” says Adam Atlas, a Montreal attorney who works with U.S. and Canadian independent sales organizations, money transmitters, and other payments-industry clients.

FinCen’s registration process is far simpler than state licensing and can be done in only about 20 minutes, according to Atlas. But even though the feds themselves don’t license money transmitters, it’s a federal crime for a money transmitter not to have the required state license in a state where it does business.

“The federal law piggybacks on the state law,” he says. “If you need a state license and don’t have one, you’re eligible for five years in federal jail.”

All of that is nothing new. What is new is that the feds are getting more involved in the money-transmitter business. On Oct. 28, new regulations from the Consumer Financial Protection Bureau take effect that cover international money transfers.

These regulations will cover such matters as disclosures, resolution of errors arising from incorrect transaction information, exchange rates, and recourse. Senders, for instance, will have 30 minutes from the time of payment to cancel a transaction.

While the new CFPB rules will not apply to domestic money transfers, they are yet another signal of increasing governmental interest in the sector.

“The new regulation is going to prevent some of the riffraff from operating,” says Aite’s Fridman.

But is keeping the riffraff out also keeping out some of the good guys who might have a useful product or service to sell but don’t have enough resources to pay lawyers and cover other expenses for money-transmitter licenses? Greenspan of Think Computer believes that’s the case.

Greenspan signed a few restaurants and consumers for his fledgling FaceCash mobile-payments service, which enabled consumers to pay merchants by displaying photos of themselves and unique identification bar codes, but he put it on ice after encountering problems in obtaining a California money-transmitter license.

In November 2011, Greenspan sued the state in federal court to challenge the constitutionality of the state’s transmitter law, saying it granted bureaucrats too much power and was stacked in favor of industry incumbents. He said he continually sought but never received clarification from state officials about exactly what he needed to do to get a license.

The lawsuit is still pending. Meanwhile, the California Legislature this summer passed a bill amending the money-transmitter law to ease some of its requirements, a bill which as of early September was awaiting Gov. Jerry Brown’s signature.

The bill, AB 786, “would reform the California Money Transmission Act and provide clarity for existing licensees like PayPal and assist with removing market-entry barriers to startup payment technology companies,” its sponsor, Assemblymember Roger Dickinson, D-Sacramento, said in a statement. The bill also would lower a license applicant’s required net worth from $500,000 to $250,000.

But the outspoken Greenspan ridicules the bill, saying it will do little to help companies like his. As with the original law, he says the bill still grants far too much authority to regulators in approving or rejecting license applications.

“It’s a colossal joke,” Greenspan says. “It gives the [California] Department of Business Oversight complete, unfettered discretion.”

Others have less caustic takes on AB 786. Meracord’s Remsberg agrees that “many things still are not changed, and the commissioner still has a lot a discretion.” But she adds: “From personal experience I found that discretion to be fair and helpful. I haven’t had the kind of experience that some of the others have had.”

Xoom’s Ferro says, “I certainly empathize with the problem that startups have,” but notes that “we were a startup once and we had to deal with those issues, and we did just fine.”

In contrast to traditional money transmitters, Xoom decided against building an agent network. Instead, it’s having success using a model built entirely on online and mobile transactions for money transmission. Its active customer of nearly 920,000 as of June 30 was up 40% from a year earlier, and in September the company raised $86 million in a post-IPO stock offering that attracted strong investor interest.

‘Flavor of the Month’

State officials charged with overseeing their money transmitters have their own trade group, the Money Transmitter Regulators Association (MTRA). Despite several requests from Digital Transactions, the MTRA did not make an official available for an interview for this story. But statements from officials in Illinois and New York likely reflect common feelings among regulators nationwide about money-transmitter licensing in the high-tech era.

In the wake of Square’s licensing issue, a spokesperson for the Illinois Department of Financial and Professional Regulation told Digital Transactions News last March that regulation of money transmitters is “a consumer-protection issue.” The issue is becoming more important with the growth of online payments that by nature are more anonymous than in-person transactions, which provide an element of assurance for the consumer.

“We periodically get complaints about money transmitters,” the spokesperson said. “It’s become a bigger issue than if you walk into a store and need to use cash or a credit card or a check, when it’s a face-to-face transaction. There have always been transmitters of money, but the use of companies that focus their energies on online transactions—it makes it even more important that these people be licensed.”

New York financial superintendent Lawsky expressed a similar mindset in his Aug. 12 notice announcing the inquiry into virtual currencies.

“The emergence of Bitcoin and other virtual currencies has presented a number of unique opportunities and challenges,” he said. “Building innovative platforms for conducting commerce can help improve the depth and breadth of our nation’s financial system. However, we have also seen instances where the cloak of anonymity provided by virtual currencies has helped support dangerous criminal activity, such as drug smuggling, money laundering, gun running, and child pornography.”

He added: “If virtual currencies remain a virtual Wild West for narcotraffickers and other criminals, that would not only threaten our country’s national security, but also the very existence of the virtual-currency industry as a legitimate business enterprise.”

Payments attorney Atlas won’t be surprised if more states follow New York’s lead.

“The flavor of the month is Bitcoin exchanges and virtual currencies generally,” he says.

‘National Security’

Atlas won’t name client names, but he says some U.S.-based payments firms have moved to Canada, or to a lesser extent to Europe, to escape what they see as increasingly onerous regulation of money transmitters by states.

“Entrepreneurs are taking their business elsewhere,” he says. “I wouldn’t say they’re leaving in droves, but the ones that bother to talk to a lawyer to get the real deal are saying, ‘I can’t make a go here.’”

Some say national licensing by the federal government is the logical alternative to a hodgepodge of state regulations. Backers say such a system would not only make doing business for money transmitters easier by having just one set of rules to comply with, but it also would apply protections to residents of the remaining states that still don’t license money transmitters.

“The consumers in South Carolina, Montana, and New Mexico are no less deserving of protection,” says Landsman of the NMTA, whose organization supports a national law. “The protection of consumers should be made uniform across all states.”

Aite’s Fridman adds: “I’m certainly for a national licensing requirement, or federal, as opposed to state regulation.”

At this moment, though, prospects for federal regulation seem slim, which means the fast-changing money-transmitter industry may need to make peace with its state overseers. So again, does state regulation stifle innovation and new competitors, at least to some degree?

“I think the short answer is yes,” says attorney Atlas.

But, in a concession to reality, Atlas states the question many of his clients would then ask, though they may not agree with his answer.

“Do we get rid of it? Absolutely not—it’s a question of national security.”

Who Needs a License?

So, just who is a money transmitter?

“In plain English, a money transmitter is an entity that agrees to transfer value from one person to another,” says payments attorney Adam Atlas.

State laws about who needs a money-transmitter license have many common features but can vary somewhat. Atlas, who works with U.S. and Canadian clients from his Montreal office, says the fast way to make a determination is to consider the definition from Title 31 of the U.S. Code of Federal Regulations.

In general, the code reads, a money transmitter is:

– “A person that provides money transmission services. The term ‘money transmission services’ means the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.

– ‘Any means’ includes, but is not limited to, through a financial agency or institution; a Federal Reserve Bank or other facility of one or more Federal Reserve Banks, the Board of Governors of the Federal Reserve System, or both; an electronic funds transfer network; or an informal value-transfer system; or

– Any other person engaged in the transfer of funds.”

The law, however, goes on to describe various “facts and circumstances” and limitations that would exclude a person or business from being considered a money transmitter. Some excluded entities include those that provide only communication, network-access, and processing services to money transmitters, or act as intermediaries.