By Theodore Monroe and Brad Cebeci
Law Offices of Theodore F. Monroe
In August 2015, an Illinios state regulator quietly lifted its January 2013 cease and desist order against Jack Dorsey's payment processor Square Inc., reversing its decision to deem Square a money transmitter.
Apparently, this decision is the result of a policy change by the Illinois Department of Financial & Professional Regulation exempting third-party payment processors from licensure requirements under the Illinois Transmitter of Money Act (TOMA). The IDFRP stated that, upon closer review, the department had determined that third-party payment processors such as Square merely act "as the agent for the merchant accepting and processing funds" and are therefore not engaged in "money transmission" activities within the meaning of TOMA.
The IDFRP also explicitly acknowledged the importance of regulatory clarity on this point to enable "technology innovators to plan with greater certainty and incur less cost associated with regulatory activity."
The IDFRP unquestionably reached the right decision, and its analysis closely accords with federal law, which is important because it promotes regulatory predictability on the issue. But the jury is out regarding whether the rest of the states and the federal government are on board with a comprehensive policy that would encourage innovation.
Under the federal Bank Secrecy Act (BSA), any person engaged in "money transmission" is subject to mandatory registration as a money services business (MSB) with the Financial Crimes Enforcement Network (FinCEN) Division of the United States Department of the Treasury. The BSA's broad definition of "money transmitter" includes "[a]ny other person engaged as a business in the transfer of funds." [31 Code of Federal Regulations (CFR) 103.11(uu)(5)(i)(B).]
Yet that definition is subject to the limitation that, whether a person is engaged in money transmission activities is a question of "facts and circumstances," and that, "generally, the acceptance and transmission of funds as an integral part of the execution and settlement of a transaction other than the funds transmission itself (for example, in connection with a bona fide sale of securities or other property) will not cause a person to be a money transmitter" within the meaning of the BSA. [31 CFR 103.11(uu)(5)(ii) – emphasis added.]
Recent FinCEN rulings provide compelling guidance on this issue. For example, in concluding that a business providing third party origination services for ACH transactions on behalf of merchants does not fall within the BSA's definition of "money transmitter," FinCEN explained that, where the third-party "acts on behalf of merchants receiving payments rather than on behalf of customers making payments … the service … more closely resembles payment processing/settlement than money transmission.
"Therefore, to the extent that the [third-party provider's] role … in such transactions is limited to submitting payment instructions obtained from a merchant to a bank for ACH processing, and remitting the funds received through the ACH process to the merchant (or in some cases, refunding money to the merchant's customer through an ACH transaction), FinCEN would not deem [the third-party provider] a money transmitter for purposes of 31 CFR 103.11(uu)(5)." (FinCEN Ruling 2003-8 – Definition of Money Transmitter (Merchant Processor).
Similarly, in concluding that an authorized agent for the receipt of utility payments is not a money transmitter, FinCEN referred to the above ruling and stated:
"FinCEN has concluded that a merchant payment processor, processing payments from consumers as an agent of the merchant to whom the consumers owe money – rather than on behalf of the consumers themselves – is not a money transmitter by virtue of such activities. As long as [ ] limits itself to accepting payments only on behalf of the utilities with whom it has contracted as an agent, and declines to accept and transmit funds for any other purpose, [ ]'s activities are sufficiently similar to the services provided to merchants by merchant payment processors for the same conclusion to apply. Under these circumstances, therefore, FinCEN would not deem [ ] a money transmitter for purposes of 31 C.F.R. § 103.11(uu)(5)." (FinCEN Ruling 2008-R006 – Whether an Authorized Agent for the Receipt of Utility Payments is a Money Transmitter.)
In light of these FinCEN rulings, it should be obvious that the IDFRP reached the right decision here: Square should not be deemed a "money transmitter" for facilitating a merchant's ability to accept mobile payments for goods and services by using the Square Register tool.
In the case of a third-party payment processor such as Square, the acceptance and transmission of funds is an integral part of the settlement of the transaction between the merchant and the consumer rather than the funds transmission itself. Furthermore, as the IDFRP emphasized in announcing its decision, Square is merely acting as the agent for the merchant selling goods and services rather than for the customer in such transactions, and contractually agrees to transmit funds for that limited purpose only. Thus, under federal law, the result is clear: Square is not a "money transmitter" within the meaning of the BSA.
We can only hope that more states will openly adopt the same common sense policy in interpreting their own respective money transmitter licensing statutes. Where a payment facilitator is not subject to MSB registration requirements as a money transmitter under the BSA, it makes little sense that the same payment facilitator may be subject to individual state licensing requirements as a money transmitter.
Regulatory inconsistency on this question among the various state regimes stifles innovation and keeps emerging and innovative companies out of the game. Eliminating this doubt by adopting a consistent regulatory standard across the board would dramatically stimulate further innovation in emerging payments by granting broader entry to upstart payment facilitators that would otherwise lack the resources to go through (or risk running afoul of) the rigorous "money transmitter" licensing process in each state in which they intend to do business.
Theodore F. Monroe and Brad Cebeci, Payments Attorneys, can be reached by phone at 213-233-2272 or by email at monroe@tfmlaw.com.
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