The scope of state law threatens the viability of new payment systems.
Every day, countless transactions take place online. With the click of a button, customers can purchase items from anywhere in the world without having to leave their homes. Services like Paypal have radically transformed the nature of modern-day trade, allowing customers and vendors to connect without face-to-face interactions.
However, these payment systems may be under threat, according to Kevin Tu, an assistant professor at the University of New Mexico School of Law. In a new paper, Tu argues that Internet and mobile payment organizations face considerable uncertainty about whether they are subject to state money transmitter laws.
Developed in a different era, these laws apply broadly to businesses that receive money for the purpose of transmitting it. They impose costly licensing and compliance requirements on the entities that they regulate. Unless these laws change, Tu claims that they “may stifle continued innovation” in the payment industry and impose unnecessary burdens on existing payment service providers.
State money transmitter laws regulate all activities that constitute “money transmission,” which states define broadly. In Maryland, for example, the applicable state law specifically covers the reception of any money for transmission “by any means, including electronically or through the Internet.”
Tu explains that states developed money transmitter laws to protect consumers from the financial losses associated with conventional money transfer businesses, like Western Union. Under the conventional model, the money transfer business provides a service on behalf of the customer. The customer pays the money transfer business to take their money and transport it to their desired recipients, usually in a different location. In such scenarios, the state has an interest in protecting consumers from the risk that money transfer businesses will fail to deliver the funds as agreed and cause their customers to lose their money.
To that end, state money transmitter laws typically impose licensing and compliance requirements on entities engaged in money transmission. The license application process often includes the payment of a fee and an investigation into the applicant’s character, financial situation, and business background.
Compliance requirements typically include, for example, obligations to meet minimum net worth requirements, post a surety bond or other security, and submit financial reports. Failure to comply with these requirements can result in criminal and civil penalties. Tu notes that these burdens on the entities regulated by money transmitter laws can be “onerous and costly,” especially where the money transfer business seeks to operate in multiple states.
Tu argues that the broad language of money transmitter statutes, while providing states leeway for regulating conventional money transfer businesses, is problematic. Vague definitions of money transmission, like that in Maryland’s statute, can be read to cover nearly all commercial activity where money is transferred from an individual or location and furnished to another—provided that the money transmission is conducted as a business. As a result, Internet and mobile payment systems might be caught in their sweep.
Tu cites several types of Internet and mobile payment systems that could be understood as involving money transmission. “[P]ayment processing services for third party sales on a hosted marketplace,” such as Amazon or check-out services for a vendor’s website, would likely meet the definition. Mobile wallets, like Level Up, which allow vendors to receive payment data from the purchaser’s SmartPhone, would probably qualify as well.
In the face of uncertainty, entities that suspect that their activities might be subject to money transmitter laws experience higher information and search costs when attempting to determine whether the laws apply to them. Large companies—like Amazon, Google, Facebook, and PayPal, all of which chose to obtain licenses as money transmitters—may have the means to investigate their susceptibility to regulation under money transmitter laws, obtain the required licenses, and act in accordance with these regulations. However, smaller companies, like start-ups, may not. Tu argues that the disparate impact of the uncertainty on start-up firms functions as a barrier to market entry and may hinder innovation in the payment industry.
These downsides to a broad interpretation of the money transmitter laws are not offset by a consumer protection rationale, according to Tu, because the new payment systems pose a lower risk of consumer loss than exists under the conventional money transfer model. With many of the new money transfer businesses, the vendor contracts directly with a service provider to have the service provider receive and process payments on its behalf.
In Tu’s view, under this arrangement, the customer’s transfer of payment to the service provider is tantamount to delivery to the vendor. Typically, a customer making a purchase through an Internet or mobile payment system obtains the item paid for, regardless of whether the service provider delivers payment to the vendor; a failure to deliver payment would be addressed between the vendor and payment service provider under the terms of their contract.
Therefore, the customer in this scenario faces virtually no risk of loss. Tu concludes that the consumer protection rationale of state money transmitter laws is not served by bringing these new payment arrangements within the scope
of the laws.
Tu calls on state regulators and legislators to examine state money transmitter laws and clarify their applicability to Internet and mobile payment systems. He urges for states to adopt an “agent of a payee” exemption according to which state money transmitter laws would not apply to an agent (the payment service provider) of the payee (the vendor) where certain conditions are met: where the payee and agent have a “valid written agreement” with “enforceable terms and conditions;” and, where the written agreement specifies both that the delivery of payment to the agent is considered delivery to the payee and that the payee cannot hold the customer responsible for an agent’s failure to deliver payment.
Because such a framework would grant an exemption only where the risk of loss to the customer would be removed by these protections, Tu believes that this framework strikes an appropriate balance between addressing consumer protection concerns and removing obstacles to innovation and efficiency in the payment services industry.