Three years ago Aaron Greenspan had a hot mobile payments startup on his hands that was poised to take a bite out of the entrenched card networks.
Launched in April 2010, FaceCash signed up 25 Bay Area merchants and 500 consumers to use its novel technology, which combined mobile bar code scanning and photo identification. A Subway franchise in Palo Alto tested the service. Some suggested FaceCash could become the next blockbuster payments innovator after Jack Dorsey's Square.
Then regulators put Greenspan out of business.
In 2011, a new state law took effect that put fledgling payments companies at the mercy of the California Department of Financial Institutions. That April, the department notified Greenspan that FaceCash required a domestic money transmitter license under the new law. After a discouraging meeting with regulators in mid-June, Greenspan says, he spent weeks trying to get clear answers from the state: What steps did FaceCash have to take to get licensed? How much capital did it need?
No guidance was forthcoming. Instead, Greenspan says, a state examiner warned him to give up.
"I was literally told, 'You will go to federal prison if you don't shut down,' " he says.
While an extreme example, Greenspan's story highlights a broader problem, one that threatens to constrain innovation in financial services at a time when the industry desperately needs to catch up with changes in technology and consumer preferences.
Across the country, state money transmitter licensing requirements are potentially barring or at least slowing young businesses from entering the payments field. But the issue is especially salient in California, which is home to one of the country's biggest clusters of startups, in Silicon Valley, and has one of the toughest laws. Its requirements are opaque, outdated and inapplicable to emerging business models, the process expensive and time-consuming, critics argue.
Greenspan (no relation to Alan) is hardly the ideal poster child. With a history of making sensational claims (he's alleged that his Harvard classmate, Mark Zuckerberg, stole his ideas for Facebook) and filing lawsuits (naming more than a dozen Silicon Valley investors and money services businesses in the last 12 months), he has acquired a reputation as a crank.
But when it comes to the effects of California's money transmitter law, cooler heads say Greenspan has a point.
"Is it stopping innovation? Certainly," says Bradley Leimer, the head of digital strategy at Mechanics Bank in Richmond, Calif. "Is it stopping competition to be able to provide smaller startups with the ability to move money? Absolutely."
State money transmitter regulations in general are unduly onerous for companies that pose little risk to the consumers they are ostensibly designed to protect, critics say. "You are not talking about people who are trying to set up a bank, or people that are trying to set up complex derivatives," says Dave Birch, the founding director of Consult Hyperion in the U.K. "It's really just people that are trying to send 10 bucks from Place A to Place B."
The burdens are stifling creativity at a pivotal moment for payments, warns Birch, who focuses on payments technology.
"This is a time where we need more experimentation," he says. "You have tremendously innovative people, especially in the mobile space, that need to be freed up to come up with new solutions."
California has long required licenses for foreign money transmission, but didn't require domestic money movers to obtain a license until then-Gov. Arnold Schwarzenegger signed the Money Transmission Act, or MTA, in 2010. The law, which took effect in the beginning of 2011, also collapsed three different licenses — one for travelers check issuers, another for money order sellers and a third for foreign money transmitters — into one.
PayPal and others that already had the old kinds of licenses didn't need to reapply for the new ones. But new entrants were left to navigate a set of befuddling guidelines.
For instance, applicants must schedule interviews with California regulators before they can even put in the paperwork. And the law gives the commissioner of the Department of Business Oversight (successor to the agency that foiled Greenspan) great leeway in deciding who does, and does not, get a license. The minimum net worth for licensees is $500,000, but the exact amount required of any applicant is left to the commissioner's discretion.
If rejected, an applicant can appeal the commissioner's decision to a judge. But the appeal process can begin only if the commissioner makes a decision one way or the other. There is no rule saying a commissioner has to make a decision, though a judge can force her to.
Of the 45 applications that were filed between 2011 and the end of July, 31 licenses were issued. But a company is unlikely to apply unless it is fairly certain of success.
FaceCash never formally applied for a license. Without a clear sense of the prerequisite requirements, Greenspan says, he feared losing the nonrefundable $5,000 application fee. After shuttering FaceCash in mid-2011, he sued the state, claiming, among other things, that the department violated his right to due process by refusing to provide the information he needed to apply for a license "with a reasonable chance of approval."
Two California attorneys at separate firms representing clients with active applications say the law is by far the country's most onerous when it comes to capital requirements.
Teveia Barnes, commissioner of the Department of Financial Institutions from 2012 until last month (when it merged with the Department of Corporations to form the DBO), has acknowledged licensing decisions are subjective.
"It's really an art form in that we don't treat every applicant the same," she said in March, at a hearing of the California Assembly Banking and Finance Committee. (Barnes is now the executive director of the California Infrastructure and Economic Development Bank.)
At the same hearing, Barnes hinted that the department preferred to award licenses to companies with ample capital — which startups lack, particularly in the early stages.
"I view the holding of other people's money in the same vein as I view bank deposits," she said. "I don't think they are barriers to entry, I think they are consumer protections."
Barnes and her successor, Department of Business Oversight Commissioner Jan Lynn Owen, did not respond to requests for comment submitted through a spokeswoman. The department never responded to a list of questions asked by email.
William Haraf, Barnes' predecessor who ran the department when FaceCash was in operation, is now a managing director at Promontory Financial, the high-powered Washington consulting firm known for hiring former regulators. He declined to discuss the MTA for this story.
The chairman of the California Assembly's Banking and Finance Committee is attempting to reform the MTA. At the beginning of the year, assemblyman Roger Dickinson, D-Sacramento, introduced a bill that would amend the law, making the commissioner's decisions more transparent and, most important, lowering the capital requirements to between $250,000 and $500,000 in equity, depending on the amount of money a licensee is moving.
"What's occurring in the real world is changing very rapidly," Dickinson says. While "leaving enough flexibility to allow additional innovation and change," he says, the amendment would "at the same time ensure … there are adequate protections for consumers. So there is a balancing … of trying to protect new and innovative techniques and approaches, on the one hand, but at the same time preserving guarantees."
Still, the proposed amendment to the MTA would leave the commissioner of the DBO plenty of wiggle room in deciding who to give a license on the basis, for example, of the quality of an applying company's operations and management.
The earliest that amendment would be approved is by the end of this month. The California Legislature returned from recess Aug. 5.
State laws nationwide tend to define money transmission so broadly that even bike messengers and app stores would appear to require licenses in some jurisdictions, according to a recent paper by Kevin Tu, an assistant professor at the New Mexico School of Law.
Most states exempt the U.S. Postal Service and banks from money transmitter licensing requirements. There are other exemptions, but "they vary from state to state, so there is no consistency," Tu says. "And as a general matter, there are few if any exemptions that might arguably apply to exempt some of these new mobile payment systems from the licensing requirements."
(These laws, framed as consumer-protection measures, are separate from the federal registration, reporting and recordkeeping requirements for financial institutions designed to combat money laundering.)
In his paper, Tu calls for reforms that would narrow the scope of state regulations to cover only "services that pose a real risk of loss" to the consumer. A traditional money transmitter like Western Union, entrusted to deliver a consumer's money to a recipient, would remain fair game. But third-party mobile and Internet payment providers, which accept money from customers on merchants' behalf, would be exempt, since the consumer is not affected if the provider stiffs the merchant.
California's definition of a money transmitter is so broad that even households could be considered within regulators' purview, says Tom Brown, a partner at the law firm Paul Hastings in San Francisco.
"It's written in such a way as to be enforceable against any business or household because the critical language is a money transmitter is defined as somebody who receives money for others," Brown says.
Some entrepreneurs are ignoring the rules altogether, says Omar Green, a former Intuit executive who left his post last October to launch a personal financial management startup called wallet.AI, based in San Francisco.
"I think what's happening in this space right now, in general, is an attempt by some very, very small, well-meaning and enterprising companies to figure out how to open up some of the controls," Green says. "The shortest path to do that is to do things, make mistakes and ask for forgiveness later and that's very often what the strategy is."
Of course, that's a high-risk strategy. Under the USA Patriot Act, the federal government can bring felony charges against a company caught acting as a money transmitter without the blessing of one of the states.
Even if a business gets permission in California, doing business nationwide requires licenses in all the 48 states that require such approval. Not long after his run-in with California regulators, Greenspan estimated in a white paper that at minimum, an applicant trying to gain licenses nationwide would need to obtain at least $7.8 million in surety bonds and spend nearly $71,000 on application and licensing fees.
To that end, some are arguing for one national standard rather than many separate state laws.
"I think we need to go federal," says David Landsman, executive director of the National Money Transmitters Association. "What we have now is exactly like having a separate FAA in each state."
Greenspan, more than any other applicant, has been screaming about the California MTA since its inception. He's responsible for bringing it to the attention of reporters and lawmakers.
During its 14 months of operation, FaceCash offered a reduced-friction alternative to credit and debit cards. Instead of swiping a piece of plastic at checkout, a shopper would scan a barcode from a mobile phone (a method later made popular by Starbucks). Instead of asking for a signature or PIN, the cashier would eyeball a photo of the accountholder's face on the terminal screen to make sure it matched the customer's. And instead of paying anywhere from 2% to 5% to accept a credit card, the merchant would pay FaceCash just 1.5%. (The funds were withdrawn from the consumer's prepaid FaceCash account.) The technology was deployed primarily in restaurants and stores on Stanford University's campus and across Palo Alto.
When American Banker interviewed him in mid-May, Greenspan was sharing a ranch home in the center of Silicon Valley littered with reminders of his personally financed, million-dollar venture. (He has said regulatory uncertainty prevented FaceCash from raising the venture capital that might have helped the outfit meet the state's nebulous net-worth requirements.) The scene was reminiscent of a college dormitory.
The first thing visible past the front door was an outdated point-of-sale machine propped against the couch. Across from that there was a flat screen connected to a Wii and an XBox.
Greenspan's circumstances have clearly weighed on him. Well-worn clothes hang off his gaunt frame. He now lives off a pittance he makes from PlainSite, a legal project partly supported by Stanford's law school, and from his savings — most likely from a legal settlement over Facebook's trademark.
Greenspan says his litigious streak is born out of a sense of right and wrong. He draws a parallel between his fight with California to offer mobile payments and his adult autistic brother's fight for access to social services.
"I don't view money as being the most important thing in the world," Greenspan says. "It's a combination of that idealism and the absolute intolerance for all of these things that most people just take for granted because that's just the way they are. Because if you just let all that stuff slide, people like my brother die."