Weekly Fintech Focus

  • Federal banking agencies issue joint statement on enforcement of the BSA.
  • The California DBO issued an interpretive opinion declaring a payment processing arrangement not to be exempt under California’s agent-of-the-payee exemption for pay-in and pay-out transactions for online gambling.
  • The California DBO issued an interpretive opinion that maintains its position that cryptocurrency is not money under the Money Transmission Act, but certain crypto-activities could trigger the state’s escrow law.
  • The Federal Reserve discusses its efforts at developing and experimenting with a digital dollar and distributed ledger technology.

Federal Banking Agencies Issue Joint Statement on the Enforcement of the BSA

The Board of Governors of the Federal Reserve System (the Fed), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC) (collectively, the Agencies) issued a joint statement that updates their existing enforcement guidance to enhance transparency regarding how they evaluate enforcement actions that are required by statute when financial institutions fail to meet Bank Secrecy Act (BSA) and other anti-money laundering (AML) obligations.

In particular, the joint statement highlights the Agencies’ policy on issuing a mandatory cease and desist order to address noncompliance with certain BSA/AML requirements like section 8(s) of the Federal Deposit Insurance Act and section 206(q) of the Federal Credit Union Act.

As background, section 8(s) and section 206(q) prescribe the following:

  • They direct the Agencies to prescribe regulations that require each insured depository institution to establish and maintain procedures reasonably designed to assure and monitor compliance with the BSA.
  • They require that each of the Agencies’ respective examinations include a review of the BSA/AML program and document any problems with such.
  • They state that failure to establish and maintain a BSA/AML program or failure to correct any problems previously reported shall result in a cease and desist order against the financial institution.

At a high-level, the joint statement clarifies in detail that failure to have a written BSA/AML program, failure to implement the program, and defects of the program with one or more of the pillars would be subject to a mandatory cease and desist order. Moreover, a cease and desist order will be issued whenever an institution fails to correct a previously reported problem with its BSA/AML program that has been identified during the supervisory process. This extends to uncorrected, repeat violations of the same reported deficiency, including patterns of not reporting suspicious activity and not sufficiently training personnel.

Notably, the Agencies expressly state that the joint statement does not create new expectations or standards, but rather it is intended to further clarify the Agencies’ enforcement of the BSA and the conditions that require the issuance of a mandatory cease and desist order.

California Issues Opinion About Payment Processing That Is Not Exempt as Agent-of-the-Payee

The California Department of Business Oversight (DBO) recently issued a redacted interpretive opinion letter responding to a company that provided payment processing services to online gaming operators (the merchants) and allowed their customers to submit payments to engage in online gaming and gambling, such as sports betting and daily fantasy sports. The payment processor enabled customers to pay-in to merchants and merchants to pay-out to customers. The pay-in transactions are initiated by the customer on the merchant’s website, and the company would process the payment by pulling the funds from the customer’s bank account to the company’s own bank account for the benefit of the merchant. The company would then send funds directly from its FBO account to the merchant’s corporate bank account periodically. In the reverse direction, the merchant’s pay-out transactions go from the merchant’s corporate bank account to the account at the payment processor’s bank.

The payment processor’s agreements with the merchants and customers designate the payment processor as the merchant’s agent but do not designate the payment processor as the customer’s agent. In the merchant agreement, the payment processor is designated as the agent of the merchant for the purpose of collecting funds from customers, so that delivery of the funds from the customer to the payment processor is considered to satisfy fully the customer’s obligation to the merchant. However, the customer’s agreement with the payment processor does not create the same agency relationship, so the payment processor is not acting as customer’s agent for purposes of pay-out transactions from the merchants.

The DBO frequently exempts payment processors as agents of the payee, but not in this case. The agent-of-the-payee exemption applies where the recipient of the money is an agent of the payee pursuant to a preexisting written contract and delivery of the money to the agent satisfies the payor’s obligation to the payee for the goods or services provided. In early 2019, the DBO issued a series of interpretive opinions about payment processing services that were not exempt under the agent-of-the-payee exemption. This opinion provides another example of non-exempt activity.

The agent-of-the-payee exemption does not apply here because the payment processor “receives money for transmission” in both the pay-in and pay-out transactions. In the pay-in transaction, the money received by the payment processor is not owed by the customer to the merchant as the customer has no obligation to prefund the merchant’s account to participate in online gaming activity. Similarly, in the reverse direction, the pay-out transaction involves the payment processor receiving money from the merchants to transfer to customers, but the customer does not provide any goods or services to the merchant for which payment is owed.

California Issues Opinion on Crypto Escrow Services Under the Money Transmission Act

Recently, the California DBO opined on certain crypto escrow services under the Money Transmission Act (MTA). Sticking to its ongoing position that cryptocurrency does not trigger the application of the MTA, the DBO held that brokerage accounts that used cryptocurrency exchanges would not be considered licensable activity under the MTA. This does not mean that cryptocurrency activities could not trigger any licensing regime under California law, and the DBO in its opinion cautions that some of the services proposed in the opinion-requesting letter could trigger obligations under the California Escrow Law (Financial Code 17000 et seq.).

The opinion-requesting company presented two proposed business models to the DBO for evaluation—a tri-party repurchase transaction model and a prime brokerage model.

In the tri-party repo model, the company would act as a third party to a repurchase transaction related to borrowing and lending cryptocurrency. The borrowing and lending parties would agree to the terms of the transaction and place the agreed-upon amount of margin from their digital wallet into an escrow account held by the company, which is empowered to move the funds between the accounts and send funds to the originating wallet. At the conclusion of the transaction, the company would send the escrow balances back to the originating wallet, or, in the event of a default, to the non-defaulting party’s escrow account.

In the prime brokerage model, customers would open accounts through the company to facilitate exchanges on a number of cryptocurrency exchanges with the company maintaining corporate accounts at the exchange. The customers could fund the brokerage account with cryptocurrency from the customer’s wallet to the company’s corporate account at the exchange, or the customers can wire fiat currency to the company’s bank account, which is then transferred to the company’s account at the exchange. The company has control and ownership over the funds in the accounts, but only moves those funds at the customers’ direction.

As the CA MTA does not consider cryptocurrencies to be a form of money, neither of these business models triggers licensure requirements under the MTA. However, these business models, and particularly the tri-party repo model, could be escrow activity requiring licensure under the California Escrow Law.

The Federal Reserve Is Testing a Digital Dollar and Distributed Ledgers

On August 13, 2020, Federal Reserve Governor Brainard gave a speech during a webcast of the Federal Reserve Bank of San Francisco’s Innovation Office Hours, discussing the Federal Reserve’s development work and experiments with a digital dollar or Central Bank Digital Currency (CBDC). Governor Brainard noted that the Federal Reserve “is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies.” To study the potential of technologies offering digital currencies or digital equivalents of cash, the Federal Reserve has been conducting in-house experiments with digital currencies for the past few years through the Federal Reserve’s Technology Lab, including building and testing distributed ledger platforms to understand the risks and opportunities in the technology. Notably, Governor Brainard did not promise the issuance of a digital dollar and emphasized the significant policy process necessary to operationalize a CBDC as well as the high demand for the current U.S. dollar.