Internet Startups: Beware of Being a Money Transmitter

Regina M. Joseph

Regina M. Joseph

So, you’ve got a great idea. Social media platforms are all about finding new solutions for old inefficiencies. And what’s more efficient than serving as a platform for an account holder to obtain a single cash payment in exchange for virtual currency he/she/it has received through interactions on numerous merchant sites? Or a platform aggregating other monetary remuneration due from a large number of vendors? Aggregation would be relatively easy with the right platform and software.

How might it work? A Newco could permit a user to open an account and provide the requisite claim information. Newco might serve as a clearinghouse for the cash delivery of multiple vendor rebates or bitcoins, or alternatively advance the user cash from its own reserves. In each instance, payment to a user would be remitted after Newco has retained a commission. The process solves a problem for users. But what’s wrong with this model?

It could be a crime. Under federal law and the laws of some states, Newco might be required to register as a “money transmitter” through the BSA E-Filing System. Under federal law, a money transmitter is engulfed within the regulations for a “money service business” (“MSB”) under the Bank Secrecy Act. Some states have their own definitions and regulatory schemes, although a few states participate in a central registry. (See NMLS Resource Center). Failure to register and abide by the substantive requirements might be a crime under individual statutes. This is especially true if an exchange aids users in obtaining illegal drugs.  (See U.S. Department of Justice Press Release).

Bitcoin platforms have been particularly in the cross-hairs. The Federal Crimes Enforcement Network (“FinCen”) first issued guidance in March 2013. It advised that an administrator or an exchange of bitcoins would be an MSB unless an exemption applies. (See preceding link.) This included providers of “prepaid access,” also known as e-wallets.

FinCen expanded its guidance on October 27, 2014 through the issuance of two administrative rulings.

In FIN-2014-R011, FinCen had been asked whether a convertible virtual currency trading and booking platform would constitute a money transmitter. The question was asked by a company that proposed to set up a platform that consisted of a trading system to match offers to buy and sell convertible virtual currency for currency of legal tender, and to keep a set of book accounts in which prospective buyers or sellers of one type of currency or the other could deposit funds to cover their exchanges.

Although details can be found in the ruling, suffice it here to note that the company, which was not regulated as a financial institution under the Bank Secrecy Act, had proposed to utilize regulated entities to implement the steps in the money transmission process. It thus argued that it qualified for the following exclusion from the federal “money transmitter” definition:

“(C) Operates a clearance and settlement system or otherwise acts as an intermediary solely between BSA regulated institutions.”

FinCen ruled that this exception was inapplicable because the settlement system was not one that admits only BSA-regulated financial institutions as members. In other words, an unregulated intermediary cannot avoid registration by cradling itself between regulated entities that touch the cash.

FIN-2014-R012 dealt with a platform proposed in a similar format, except that the company proposed to make payment from a currency inventory, rather than funding each individual transaction. It thus argued that the money transmitter definition was inapplicable. FinCen disagreed, “specifically because [the company] is acting as an exchanger of convertible virtual currency.” FinCen further ruled that no exclusion was applicable because “money transmission is the sole purpose of the Company’s System.” It noted that its ruling would be different if a merchant selling product exchanged currency merely as an incident to the sale.

These principles are not limited to platforms for bitcoins or even virtual currency, but apply to any platform in which monetary payment rights are aggregated by an intermediary and then cash paid (directly or through a financial institution) to an account holder. Such an innovative platform might be required to register at the federal and perhaps state levels, depending on the circumstances, and legal guidance should be sought.