Silicon Valley start-ups decry state money transmission law


California is applying money-transfer laws to high-tech start-ups and others in the business of moving funds, subjecting them to the same strict regulations and heavy scrutiny as financial service companies.

And that has some Silicon Valley entrepreneurs crying foul. The regulations, they say, are hobbling their ability to develop new Internet technologies that, like PayPal Inc. and Square Inc., make fast, secure payments with smartphones and tablets.

FaceCash, a Palo Alto company that developed a mobile payment system using facial-recognition software, has sued the state in federal court on claims that licensing requirements discriminate against the company and hinder interstate commerce.


“California and virtually every other state is attempting to regulate money transmission, an increasing subset of which is Internet,” said FaceCash founder Aaron Greenspan, who closed his firm July 1, 2011, because he didn’t have a state license.

“There is clearly this culture of fear that the law has engendered, and rightly so,” he said. “The penalties are extremely severe.”

Other start-up executives are less vocal, preferring to grouse quietly at conferences and in the trade press. They say they fear retribution from the state Department of Financial Institutions, which enforces the 2-year-old California Money Transmission Act.

At the center of the uproar is a state requirement that firms sending money domestically from one customer to another be licensed and meet stringent criteria for financial reporting, capital and bonding.

The law was “expanded to keep pace with new technology while, at the same time, continuing to protect the consumer,” Financial Institutions Commissioner Teveia Barnes said. “I strongly believe the Money Transmission Act is working as intended.”

High-tech’s consternation with portions or all of the law spurred Assemblyman Roger Dickinson (D-Sacramento) to take a fresh look at the 2010 measure, which passed the Legislature with only a handful of negative votes.


The Banking and Finance Committee he chairs met in early March to hear from business and consumer groups. Dickinson has introduced a bill, AB 786, that he can use to fine-tune the law, if needed.

“What we’re trying to do is get the law essentially updated to preserve the basic principle of making sure there is adequate consumer protection when it comes to money transmission activity,” he said, “while recognizing that methods of moving money are changing with great rapidity in ways we often can’t imagine.”

With an explosion in the use of smartphones and tablets, mobile payments are going mainstream. Some have even predicted that in the not-too-distant future people will no longer need to carry a wallet when they go shopping.

Forrester Research analyst Denee Carrington predicts that over the next five years, U.S. consumers will spend money using mobile payments at an accelerating rate: $90 billion by the end of 2017, up from $12.8 billion last year.

In 2012, 36% of online consumers with mobile phones said they would be open to making this kind of a payment in a store, Forrester Research found. That number is expected to increase as more payment options flood the marketplace that connect with the devices that are in people’s pockets.

That marketplace is still fragmented but dominant technology players such as Google Inc., PayPal and Square have a head start. They also have another competitive advantage: They are already licensed in California.


Dickinson said he is concerned that smaller tech companies that develop new products might be driven out of business because they can’t come up with the investment capital and bond payments needed to satisfy regulators.

“It’s a chicken-and-the-egg problem,” he said. “To get a license, you have to have a certain amount of capital guaranteed. But when you go to the [investors] that have the capital, they say they are not going to commit to you unless you have a license.”

As written, the Money Transmission Act is confusing, said Frank Langston and Camilo Acosta, founders of a six-person start-up in Mountain View, Calif., that makes it easier for friends to split payments on concert tickets, vacation rentals and other group purchases.

As they were setting up their company, PayByGroup, their bankers surprised them by asking them if they would be money transmitters. In response, they began weeding through a thicket of regulations. At the advice of their lawyer, they set up their company so that it would never directly handle its users’ money, Langston said.

“We wish there was more clarity. We need a more clear understanding of what does and doesn’t fall under the law,” he said. “Start-ups should not have to go through all that just to get up and running. It’s a barrier to entry.”

Start-ups often try to avoid dealing with regulators until after they know their mobile payment systems actually work and gain market share. That was the case with Square. The San Francisco mobile payments company, founded in 2009, didn’t get its California license until February.


Square, which has former U.S. Treasury Secretary Lawrence H. Summers on its board and $341 million in funding, has run up against regulators in Illinois, where it was hit with a cease-and-desist letter in January for transmitting money without a license. A Square spokesman declined to comment.

Online room rental service Airbnb and car ride service Uber have opted to piggyback on other companies’ licenses. They rely on Braintree, a Chicago payments company that makes technology to process credit card transactions on mobile phones.

In August, Braintree bought Venmo, a New York start-up that enables people to send and receive money from their friends, for $26.2 million. A Braintree spokeswoman said the company is licensed in California through Venmo.

Not all Silicon Valley companies are upset with the Money Transmission Act, especially if they already have cleared the hurdle of getting licensed. PayPal, a unit of online auctioneer EBay Inc., said being forced to be licensed by California and most other states hasn’t slowed its growth. The firm processed $165 billion worth of Internet transactions last year.

“A license has not inhibited our growth overall,” John Muller, PayPal’s vice president and general counsel, testified at Dickinson’s committee hearing. “We think there are opportunities for improvement, but it is an act we have been able to work with successfully.”

Critics of the law are proposing modifications such as sharpening definitions of who must comply and by giving start-up tech companies a pilot period to try out a new products in the market before they have to come up with $1 million or more to apply for a state license.


Although the 2010 law may be modified, it’s unlikely to be repealed, said Michelle Jun, a senior attorney with Consumers Union’s West Coast office in San Francisco.

“We haven’t heard of too many complaints about not being able to get money at all or having the transmission not go through,” she said.

“But that’s why the law exists, to make sure there won’t be any bad actors in the market, or if there are, there are fewer of them.”


Lifsher reported from Sacramento; Guynn from San Francisco.