WASHINGTON — The most-discussed idea for fintech companies trying to avoid multistate regulation is a proposed federal financial charter for the tech sector, but another potential solution already exists: the trust charter.
When two virtual currency exchanges — Gemini and itBit — last year obtained New York state trust company charters, they appeared to find a readily available antidote to multistate licensing headaches. In addition to seeking a state trust charter as a regulatory solution, some experts note certain companies could also seek a federal trust charter today, even as federal regulators discuss a specialized national charter for fintech firms.
"The custodial trust bank model would be a great platform for some types of virtual currency companies, particularly the wallets," said Pratin Vallabhaneni, an associate at Arnold & Porter.
But going the trust route is not simple either, observers say. Getting a state trust charter can allow exchanges and other companies to skip licensing as money transmitters in other states. Yet the process doesn't always work and can force a company to change its practices, while also potentially resulting in higher capital requirements and more supervision.
Trying to fit virtual currency companies into a trust company model is "kind of, 'Can you fit a square peg in a round hole?'" said V. Gerard Comizio, who chairs the global banking practice at Paul Hastings and is an adviser to digital currency companies. "You have uncertain scenarios in a number of these states that simply do not have experience with digital currency or digital currency exchanges."
In the case of both Gemini and itBit, they have had to make the case to regulators of their trust status outside New York.
"We basically told them that having that trust charter was not a get-out-of-jail-free card," said Daniel Wood, the assistant general counsel at the Texas Department of Banking, in response to questions about itBit. The company, he said, would still have to apply for a money transmission license to operate in Texas.
Still, many observers view the trust charter as a potential solution to the complex regulatory landscape for fintechs. More established trust banks can already operate on a multistate platform with just one state's license. Gemini and itBit both offer trust-related services in addition to being just exchanges, such as taking custody of users' funds in dollars and trading bitcoins over the counter.
"A non-FDIC-insured, nondepository trust company gets you the benefit of an exemption in many states from money-transmitter licensing," said Cliff Stanford, a partner and head of the bank regulatory group at Alston & Bird.
For that reason, operating as a trust is seen as more appealing by some than specialized state-backed regulatory solutions for virtual currency companies. For example, New York state has a BitLicense, but virtual currency backers have found the application process difficult, and the specialized license only works in New York.
Besides New York, other states are discussing the trust option for fintech firms. State regulators may see a benefit in having another way to appeal to new companies to set up shop locally, especially as federal officials discuss the limited-purpose fintech charter that might allow fintechs to preempt state consumer protection laws.
"It's a path that we need to explore," said Ray Grace, the commissioner of banks in North Carolina.
Grace said states would need to figure out the process for how host-state regulators deal with fintech firms chartered as a trust in another state.
"If we could work out the issues [to] give each of the participating states comfort in the manner in which the companies will be chartered and supervised," he said, "that will perhaps allow for some reciprocal participation in the examination of those companies."
But that process for multiple states to arrive at an agreement could be long and difficult.
"If they're going to do it on a bilateral basis you can think about how many levels" of coordination that would entail, said Vallabhaneni. "If you're a North Carolina trust bank, do you have to follow New York trust law?"
Some states are also suspicious of attempts to co-opt the trust charter for the benefit of companies that do not specialize in traditional trust services.
One sticking point is whether fintech firms would satisfy the duty of acting as a fiduciary, which is a typical legal obligation for trust companies to place customers' interests above the company's own.
Fiduciary duty should not be turned into a "legal artifice," Grace said. "There's a real danger we can lose some of the control we have over the business and dilute the meaning of a trust charter."
The insistence of states that fintech firms fulfill trust obligations has already complicated the process. When Gemini — a digital currency exchange founded last year by Cameron and Tyler Winklevoss — sought to be recognized as a trust in Washington state, local regulators asked the company to acknowledge it had a fiduciary duty to its customers.
"If you want to have a trust license, we expect you to have fiduciary liability," said Rick Riccobono, the former director of banks for the state's Department of Financial Institutions. "We suggested to them, 'Well, you can't [operate as a trust in Washington] unless you take out all this disclaimer about you're not a fiduciary.'"
The company, he said, complied, and is in the process of obtaining permission to act as a trust company in the state.
Gemini did not respond to requests for comment. But the bitcoin wallet did make changes in its user agreement to conform to Washington state's demands. In a user agreement dated August 2015, the company had previously said, "Under no circumstances will the operation of Gemini be deemed to create a fiduciary or trust relationship." But in the latest version of the document, the company states that for every consumer that entrusts them with fiat currency, "we will be performing as a fiduciary."
Another major obstacle to obtaining a trust charter, particularly for fledgling fintech companies, is higher capital requirements.
Stanford noted that having to hold on to more capital should be part of a firm's consideration about whether to go the trust route. Many newer fintech companies are "burning money just to cover their operating expenses," he said.
There are also other drawbacks to operating as a trust company. For one, trust charters are often modeled after bank charters, which can mean that trusts can expect to be closely supervised. In New York state, even the "limited-purpose trust" charters awarded to Gemini and itBit — which do not allow them to make loans or take deposits — come with periodic examinations.
But some also believe a separate option already exists for fintech companies to apply for a federal trust charter. As the Office of the Comptroller of the Currency has been exploring the idea of a national limited-purpose fintech charter, the agency already charters non-FDIC-insured trust companies, of which certain fintech companies may already meet the definition.
Vallabhaneni, who works with banks and fintech companies on regulatory matters, argued that some bitcoin companies, by holding the keys to their customers' funds, already do act as a type of fiduciary.
"Why would you want a national charter from the OCC as opposed to one from North Carolina?" said Vallabhaneni. "You have federal pre-emption."
But not everyone agrees with that assessment. Some experts say that a federal trust charter would be much more trouble than it is worth.
"You'd be limiting yourself to doing, if not exclusively, primarily fiduciary activities" like being a trustee, executor and transfer agent, said John Beaty, a partner at Venable. "None of those sound like virtual currency."