The world of emerging payments is booming. With the development of mobile payments, eWallets, virtual currencies, contactless chips, blue ray beacons, and photographic and geo-location capabilities, our smartest and most talented entrepreneurs are seeking to make payments safer, faster and more efficient.
But there's a problem: payments is a risky area. If mishandled, businesses can cause injury to consumers and businesses. Moreover, since payments is "where the money is," the area is being targeted by criminal enterprises, raising the specter of money laundering, financial crimes and a host of other public dangers. As a result, launching a new payments business involves exceptionally costly and burdensome compliance obligations.
State money transmitter licensing laws are among the most important rules that address the dangers posed by payments, especially in the non-bank payments area. Most Americans have never heard of these laws, but 48 states have them. They are the mechanism that allows non-banks such as Western Union, PayPal or Google to hold or move money on consumers' behalves.
Getting these licenses is difficult, expensive and exceedingly time-consuming. For example, obtaining all necessary licenses often costs between $1-2 million, and the process can take more than two years to complete. To further dampen the ability of any company to get to market quickly, it's a federal crime to do money transmission business without these licenses.
Moreover, a company needs to obtain a separate license in every state where it sells or markets its services. Europe has similar laws, but the European Union has a "passport" system that allows a registered payments company in one E.U. country to get permission do business in another E.U. country. There is nothing really comparable in the U.S. Some have called for a single national license that could take the place of multiple state licenses. But given the difficulty the current Congress has passing legislation, as well as the country's increasing tendency to move away from federal preemption, those efforts are unlikely to succeed.
So how can smart, talented entrepreneurs possibly develop and launch innovative new payment programs and still remain compliant in this environment? This issue is particularly critical because of the opportunities presented by cryptocurrencies and the block-chain structure that has the potential to revolutionize payments globally.
One of the few available options has been to partner with a company that is already fully licensed by becoming that licensed money transmitter's "authorized delegate," or agent. The authorized delegate process allows licensed entities to appoint appropriate third parties to do business under the money transmitter's licenses.
Becoming an authorized delegate of a licensed money transmitter is not easy. The licensed money transmitter becomes responsible for its authorized delegates and must report their transactions and oversee and monitor their activities. The fact that the authorized delegate is offering its services under the licensed money transmitter's license must always be disclosed to consumers. In most arrangements, the licensed money transmitter will subject the potential authorized delegate to intense due diligence, including a review of its anti-money laundering compliance procedures, anti-fraud procedures and a review of the company's history, management and banking relationships.
Given the extent of the licensed money transmitter's obligations vis-à-vis its authorized delegates, it is of course understood that the authorized delegate will pay a transaction fee (typical in the payments industry) as compensation for taking on the risks and responsibilities arising from establishing the relationship. That is not only fiscally responsible, it assists the licensed money transmitter in covering its own considerable compliance costs.
Most importantly, establishing an authorized delegate relationship between an innovative new payments company and a licensed money transmitter can create a "win-win-win-win" situation that benefits everyone. The consumers' funds are fully protected. The startup company can safely pursue its product development efforts, furthering payments innovation. The licensed entity benefits from achieving higher transactions volumes, tapping into transactions from emerging markets and increasing the value of its licenses, which are expensive to acquire and maintain. The U.S. payment system is protected, as there is no incentive for the startup payments company to do business off the grid, substantially reducing the risk of money laundering. Another beneficiary would be the states themselves, whose role in overseeing non-bank payment providers would be further strengthened and enhanced.
But there's a hitch. Unfortunately, a few bad apples generally rogue agents of licensed money remittance companies have led some states to view all authorized delegate relationships with suspicion, deeming many perfectly appropriate arrangements to be nefarious "rent-a-license" arrangements.
One case in point is the state of Washington, which decided to try to stop these arrangements by requiring authorized delegates to have a physical presence in-state. But physical location has nothing to do with whether one is "renting" a license.
Texas is another important example. Traditionally one of the most forward-thinking states, Texas recently issued a supervisory memorandum that appears to prohibit licensees from appointing any authorized delegate that is not in the same business as the licensed money transmitter. For example, a remittance company such as Western Union can appoint authorized delegates to sell Western Union's remittance products. But Western Union could not appoint an authorized delegate to offer Bitcoin exchanges, mobile payment applications or geo-location based loyalty programs.
The Texas Department of Banking explained:
With the rise of money transmission conducted via the internet, the Texas Department of Banking became aware of some unlicensed money transmitters attempting to use the AD [authorized delegate] provision in an effort to circumvent the required licensing process. These unlicensed money transmitters become appointed as an AD by entering into a contract with an MSB [money services business] that is currently licensed as a money transmitter in Texas. However, a review of the parties' relationshipreveals the unlicensed entity is actually conducting its own business and not the business of the license holder and is therefore not a legitimate AD.
But wait. What is wrong with an innovative startup payments company deciding to do licensed business through a licensed money transmitter instead of by itself? Where does the law state that a company that could be licensed must obtain its own license instead of making the business decision to become an authorized delegate? And why shouldn't a licensed money transmitter, like a bank, be allowed to market its secure payment services to others? (Would you tell a commercial entity that uses a bank for payment services, "Get your own bank charter?" Of course not.)
I realize that states are worried about so-called "rent-a-license" activities, but I think they are missing the point and a huge opportunity. Rather than try to stop licensed money transmitters from appointing unrelated yet innovative payments businesses from partnering as their authorized delegates, I urge states to consider encouraging such activity subject, of course, to reasonable state guidelines that will ensure that both consumers and the payment system are protected. Those guidelines might include:
- Requiring a written contract in which, among other things, the authorized delegate agrees to be subject to the supervision of and examination by the state regulator;
- Displaying the licensed money transmitter's name/contact information so consumers know which entity is licensed;
- Requiring the licensed money transmitter to perform due diligence on the authorized delegate, review its ownership and its AML policies and procedures;
- Requiring the licensed money transmitter to report to the states the names and addresses of all such authorized delegates, their business activities and their transaction volumes; and
- Requiring the licensed money transmitter to monitor, supervise, oversee and ultimately be responsible for the activities of the authorized delegates;
- Requiring the licensed money transmitter to hold sufficient bonds and permissible investments to cover both its own liability and those of its authorized delegates.
In recent years, many well-operated and innovative payments companies have successfully partnered with a licensed money transmitter and were thereby able to securely and lawfully launch their products. This legitimate use of money transmitter licenses and authorized delegates is truly wonderful and beneficial. It protects consumers and the payment system and provides a "safety valve" for entrepreneurs' growing demand for the ability to test and launch exciting and innovative new payments products and services. This practice should be encouraged as the best way to enhance U.S. creativity and innovation in the area of payments.
Judith Rinearson is a partner at Bryan Cave LLP and leader of the firm's prepaid and emerging payments team.