Owen Thomas / Business Insider
One of the amazing things about the latest generation of startups is how they’re creating entirely new markets, not just disrupting existing ones. That entrepreneurial impulse could be stifled by a surprisingly broad statute governing money transmission in California, Business Insider has found.
For examples of the innovation that’s happening now, look no further than Stripe, which just raised $20 million from Sequoia Capital and others to ease the processing of payments for other online businesses.
Or Airbnb, which matches people with extra space with guests who need a place to crash.
Or Zynga, which is turning the infrastructure it built for its own social games into a platform for other developers.
All of these companies are threatened by an obscure law, the California Money Transmission Act, which then-Governor Arnold Schwarzenegger signed into law in September 2010. The law took full effect just over a year ago—but businesses and regulators are still trying to take its measure.
New rules for an old economy
Previously, California had only required businesses which engaged in international money transmission to register for a money-transmitter license. Crucially, the new law governs domestic money transmission, too.
And it had a very simple, sweeping definition for who constitutes a money transmitter: a nonfinancial institution which “receives money for transmission.”
We asked the Department of Financial Institutions, which licenses money transmitters, for a clarification on which companies the law covers. Alana Golden, a spokesperson, said the department uses this plain-English test as a guide:
Do you take funds/value from A and agree to pay them to B on behalf of A; and/or Do you take funds/value from A, and store it so that A can make purchases from third parties or take cash out at a later date. What doesn’t matter? The purpose of the transactions (P to P, bill pay, pay a merchant, loan payment, etc.); how the transaction was funded (debit, cash, check, cc).
“The money-transmission statutes are worded broadly, and California is no exception,” says Jonathan Pompan, a D.C.-based attorney with Venable, who has represented clients potentially affected by the law. “Especially in California, where you have a lot of tech companies and innovation and startups, there’s a tension between that and these broadly written statutes.”
Who the law affects
Pompan’s not kidding. Taking money from A and agreeing to pay it to B?
That’s Airbnb, which takes money from guests and agrees to pay it to hosts. That’s TaskRabbit, which takes money from people who need jobs done, like say, assembling Ikea furniture, and agrees to pay it to the independent contractors who perform the work.
“Storing money so A can make purchases from third parties”? That’s Zynga, potentially. The social-gaming platform recently started opening up to third-party developers. When Zynga was selling its own virtual currencies, like FarmVille Cash, it didn’t get anywhere near this law. But now that it sells virtual currency—a form of stored value—for other businesses, it’s taking money from one party, the game player, and agreeing to pay it to another party, the independent game developer. (A Zynga spokesperson declined to comment.)
Or how about Apple? The gadget maker runs stores where it takes money from customers and agrees to pay it to app developers, book publishers, and other content creators.
It also offers iTunes gift cards and lets people keep a balance on their accounts—activities which appear to be covered by the law’s stored-value provisions.
Especially in its online bookstore, where publishers, not Apple, set the price, Apple would have a hard time arguing it’s not engaging in money transmission as the law defines it.
Apple did not respond to an emailed request for comment.
The cost of compliance
The law imposes onerous regulatory costs, including a lengthy application process, minimum capital and net-worth requirements, and in some cases, the posting of $750,000 or more in surety bonds that must be deposited with the state of California.
For startups, these can be crippling. One company, FaceCash, stopped doing business in California altogether after it found itself unable to win an exemption from the law.
Golden said the department’s made efforts to streamline the application process.
Who’s in, who’s out
Facebook and Google have registered as money transmitters, as has Xoom. PayPal, which wrestled with obtaining money-transmitter licenses early in its life as a startup before eBay bought it, has registered under the new law as well.
Amazon, Obopay, Square, and Venmo all have applications pending with California’s Department of Financial Institutions.
Technically, even those applicants are breaking the law, which required all money transmitters in business as of January 1, 2011 to get a license by July 1, 2011. But according to Golden, the department isn’t going to take action against companies that are communicating with regulators and making a good-faith effort to comply.
Airbnb says the law does not apply to it. Here’s a statement a spokesperson offered:
We have dedicated a substantial amount of effort in determining whether the California money transmitter statute applies to our model. We are comfortable that our business model does not require Airbnb to become licensed as a money transmitter in California. We will continue to monitor developments both in California and all other jurisdictions in which we operate to ensure we comply with applicable law and will have conversations with policymakers as appropriate.
Well, here’s a development. We asked the DFI if it believes the law applies to Airbnb.
The answer: Yes.
Had Airbnb sought and received an exemption from the law?
The answer: No.
Square, which seems obviously covered by the law, didn’t even apply for its license until April 2012. A spokesperson gave the following non-answer when asked to explain why it applied for its license more than 15 months after the law took effect:
We have a positive relationship and open lines of communication with the DFI and we’re always happy to speak with them.
Stripe, which helps other startups set up payment-processing without the bureaucratic mess usually associated with signing up to take credit cards online, says in its terms of service that it may hold funds on behalf of its clients before disbursing them. That would also seem to put it under the law.
“We don’t comment on legal matters,” Stripe cofounder Patrick Collison told us. “It’s mostly a no-win game.”
Stripe’s name doesn’t appear on lists of licensed money transmitters or pending applicants. Golden, the DFI spokesperson, said the department can’t comment on discussions with companies leading up to an application.
Fixing the law
So what’s the point of these laws? The main goal is protecting consumers. With the explosion of marketplace-style business models—where a startup plays matchmaker and money handler, but isn’t actually delivering the good or service—there are consumers on both sides of the transaction.
As of last month, Airbnb reported 38,000 daily guest nights booked. It holds funds and disburses them 24 hours after a guest checks in—or longer, depending on circumstances. We recently estimated Airbnb’s average nightly rate at $110. That means that Airbnb’s holding at least $4 million in guests’ funds at any point. That balance is growing rapidly as Airbnb’s business swells.
And that’s money Airbnb has received from one set of consumers for transmission to another set of consumers.
On the one hand, it makes sense that Airbnb should face some kind of regulation. And we don’t blame the Department of Financial Institutions for doing its job in enforcing the law as written. If anything, it’s been lenient.
But California’s money-transmission law strikes us as way too broad. Under a stricter regulatory regime, it could be crippling to innovation.
Stripe has just raised $20 million. Should it put that money toward complying with a law meant to catch money launderers and scammers? Or should it spend it on continuing to make taking payments easier?
We asked Golden how many consumer complaints the Department of Financial Institutions had received about money transmitters.
“Thankfully, none,” she told us.
That could be because the Department of Financial Institutions is doing its job exceptionally well.
Or because the law it’s tasked with enforcing is trying to swat a fly with a sledgehammer.