NORTH CAROLINA
BANKING INSTITUTE
+(0)"
5
..0" -/& ("
+((+2/%&.*!!!&/&+*(2+-'./ %7,. %+(-.%&,(20* "!0* &
-/+#/%" *'&*$*!&** "2+))+*.
6&.-/& ("&.-+0$%//+3+0#+-#-""*!+,"* "..3-+(&*2 %+(-.%&,",+.&/+-3/%.""* ",/"!#+-&* (0.&+*&*+-/%-+(&*
*'&*$*./&/0/"3*0/%+-&4"!!)&*&./-/+-+#-+(&*2 %+(-.%&,",+.&/+-3+-)+-"&*#+-)/&+*,("." +*/ /
(2-",+.&/+-30* "!0
" +))"*!"!&//&+*
+%*+0$(. New Wine Into Old Boles: Fintech Meets the Bank Regulatory World 8<;:<9<=>
1&(("/ %7,. %+(-.%&,(20* "!0* &1+(&..
NEW WINE INTO OLD BOTTLES: FINTECH MEETS
THE BANK REGULATORY WORLD
JOHN L. DOUGLAS*
I. INTRODUCTION
We seem to be in the midst of an extraordinary transformation of
the business of banking as technology companies seek inroads into what
has traditionally been the core ambit of banking.
1
From marketplace
lenders, digital currencies and computerized investment management to
novel applications of blockchain technology, new competitors are ex-
ploiting legacy inefficiencies in our financial system to provide greater
convenience, lower costs and novel services to businesses and individu-
als.
2
Global investments in the financial technology (or “fintech”) in-
dustry are estimated to have grown from $4.05 billion in 2013 to $12.21
billion in 2014, a 201% increase.
3
Banks alone have invested $2 billion
in fintech start-ups since 2010.
4
As a result of the emergence of well-
* Partner, Davis Polk & Wardwell LLP; General Counsel, Federal Deposit Insurance
Corporation, 1987–1989. The author expresses his gratitude to the superb contributions of
Charles Steele, Reuben Grinberg, Kimberly Chehardy, Jacob Herz, and Hanna Robinson in
the preparation of this article.
1
. See, e.g., JULIAN SKAN ET AL., THE FUTURE OF FINTECH AND ABANKING: DIGITALLY
DISRUPTED OR REIMAGINED? 3 (2015); MIKLOS DIETZ ET AL., CUTTING THROUGH THE FINTECH
NOISE: MARKERS OF SUCCESS, IMPERATIVES FOR BANKS (2015).
2
. See, e.g., OLIVER WYMAN ET AL., THE FINTECH 2.0 PAPER: REBOOTING FINANCIAL
SERVICES 4 (2015) (“Over the last decade, however, a new source of innovation in financial
services has emerged from financial technology start-ups (‘fintechs’) and technology compa-
nies (‘techcos’). These new firms have been quicker than banks to take advantage of advances
in digital technology, developing banking products that are more user-friendly, cost less to
deliver and are optimized for digital channels.”).
3
. SKAN ET AL., supra note 3, at 2 (noting that a “digital revolution in financial services
is under way”).
4
. Daniel Huang, Banks and Fintech Firms’ Relationship Status: It’s Complicated,
WALL ST. J. (Nov. 18, 2015), http://www.wsj.com/articles/banks-and-fintech-firms-relation-
ship-status-its-complicated-1447842603. Additionally, in 2015, firms such as American Ex-
press, Bain Capital, Goldman Sachs, MasterCard, New York Life and the New York Stock
Exchange invested $1 billion in bitcoin related start-ups. These investments are mostly driven
by the potential that these firms see in blockchain technology. Jose Pagliery, Record $1 bil-
lion Invested in Bitcoin So Far, CNN MONEY (Nov. 3, 2015),
18 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
funded fintech firms such as OnDeck,
5
Ripple
6
and Bond Street,
7
legal
services providers and consulting firms have taken note. Many promi-
nent law firms have responded to the growth of the fintech sector by em-
phasizing the strengths of their fintech practice groups.
8
Likewise, large
consulting firms have begun to market to these clients through papers,
reports and studies on fintech.
9
The direct challenges to the core business of banking posed by
http://money.cnn.com/2015/11/02/technology/bitcoin-1-billion-invested/?utm_source=
November+Newsletter&utm_campaign=ADCCA&utm_medium=email.
5
. OnDeck uses big data to determine the creditworthiness of a potential borrower with-
out the use of a loan officer and relies on more accurate information than banks do when
underwriting loans. Zeke Faux & Dune Lawrence, Is OnDeck Capital the Next Generation
of Lender or Boiler Room?, Bloomberg Bus. (Nov. 13, 2014), http://www.bloomberg.com/
bw/articles/2014-11-13/ondeck-ipo-shady-brokers-add-risk-in-high-interest-loans. OnDeck
raised $180 million from Google Ventures and Goldman Sachs, id., and raised $200 million
in an IPO. Leslie Picker, On Deck Jumps in Debut After $200 Million IPO of WebLender,
Bloomberg (Dec. 14, 2014), http://www.bloomberg.com/news/articles/2014-12-17/on-deck-
raises-200-million-pricing-ipo-above-marketed-range.
6
. Ripple uses distributed ledger technology, the same technology that powers bitcoin,
in order to improve the settlement time and costs of financial transactions. See Ripple, Our
Company, https://ripple.com/company/ (last visited Nov. 17, 2015) (explaining Ripple’s busi-
ness); John Ginovsky, “IoV”: Internet of Value, Banking Exch. (Aug. 27, 2015), http://
www.bankingexchange.com/payments/online/item/5698-iov-internet-of-value (explaining
Ripple’s use of distributed ledger technology). Ripple’s investors include venture capital
firms such as Google Ventures, IDG Capital Partners and Santander InnoVentures. Ripple,
supra 7.
7
. Bond Street provides loans to small business. Bond Street, About Us, https://bond-
street.com/about.html (last visited Nov. 17, 2015). In June 2015, Bond Street received $110
million in funding from Spark Capital and the investment bank Jefferies. Laura Shin, Bond
Street, An Online Small Business Lender, Announces $110 Million in Funding, Forbes (Jun.
18, 2015), http://www.forbes.com/sites/laurashin/2015/06/18/6616/.
8
. See generally Davis Polk & Wardwell LLP, FinTech, http://www.davispolk.com/
practices/corporate/FinTech/ (last visited Nov. 17, 2015); Cleary Gottlieb Steen & Hamilton
LLP, Financial Technology, http://www.cgsh.com/financial-technology/ (last visited Nov.
17, 2015); Wilmer Cutler Pickering Hale and Dorr LLP, FinTech, https://www.wil-
merhale.com/fintech/ (last visited Nov. 17, 2015); Reed Smith LLP, FinTech, http://
www.reedsmith.com/FinTech-Practices/ (last visited Nov. 17, 2015); Dechert LLP, FinTech,
https://www.dechert.com/FinTech/ (last visited Nov. 17, 2015).
9
. See Skan et al., supra note 2; Financial Technology Software and Services, Deloitte,
http://www2.deloitte.com/us/en/pages/risk/solutions/financial-technology-software-and-ser-
vices.html (last visited Nov. 17, 2015); Fintech: Are banks responding appropriately?, EY,
http://www.ey.com/CN/en/Industries/Financial-Services/Banking—-Capital-Markets/EY-
fintech-are-banks-responding-appropriately (last visited Nov. 18, 2015); Wyman et. al., supra
note 3; PricewaterhouseCoopers, Money is no object: Understanding the Evolving Crypto-
currency Market (2015), https://www.pwc.com/us/en/financial-services/publications/assets/
pwc-cryptocurrency-evolution.pdf.
2016] NEW WINE INTO OLD BOTTLES 19
bitcoin-based businesses, such as Coinbase
10
and BitPay,
11
Lending Club
and other customer-facing companies have received a great deal of pub-
licity.
12
Yet other fintech companies do not touch the core businesses of
accepting and holding deposits, making loans or facilitating payments.
13
Fraud recognition software, biometric identification tools, personal finan-
cial applications, pricing models, document management and countless
other innovations are transforming the way banks do business.
14
10
. Coinbase is a bitcoin wallet that allows users to store their digital currency. About,
Coinbase, https://www.coinbase.com/about (last visited Nov. 18, 2015).
11
. BitPay allows merchants to accept bitcoin as payment and in turn have money depos-
ited in their bank accounts. Tour, BITPAY, https://bitpay.com/tour (last visited Nov, 17, 2015).
12
. See Huang, supra note 4 (explaining how banks and fintech start-ups compete for
customers, but banks also feel the need to invest in fintech start-ups) Trond Undheim, Why
Banks Fear Bitcoin, FORTUNE (Nov. 20, 2014), http://fortune.com/2014/11/20/why-banks-
fear-bitcoin/ (arguing that bitcoin will disrupt banking industry because it will force banks to
innovate); Peter Rudegeair & Telis Demos, SoftBank Makes $1 Billion Fintech Bet with SoFi
Investment, Wall St. J.: MoneyBeat Blog (Sept. 30, 2015), http://blogs.wsj.com/moneybeat/
2015/09/30/softbank-makes-1-billion-fintech-bet-with-sofi-investment/ (“SoFi is one of the
larger financial technology, or ‘fintech,’ startups looking to displace banks from various as-
pects of consumer lending. . . . The SoFi round is the latest example of the money pouring
into online lenders, as part of a big bet that banks are vulnerable to nimbler, upstart online
competitors . . . .”). But see, John Carney, Online Lenders vs. Banks: Who Gets Disrupted,
Wall St. J. (Oct. 8, 2015), http://www.wsj.com/articles/online-lenders-vs-banks-who-gets-
disrupted-1444331083 (“Online lending sites like Lending Club and OnDeck Capital are at
the vanguard of so-called fintech companies destined, according to enthusiasts, to disrupt tra-
ditional banks. Yet that proposition looks increasingly dubious.”); Joe Mantone, Are Banks
Friends or Foes of Marketplace Lenders?, SNL Fin. (Sept. 11, 2015), https://www.snl.com/
InteractiveX/ArticleAbstract.aspx?id=33835076 (discussing whether banks may be “long-
term partners of online marketplace lenders” or “future competitors that quickly quash the
startups”); Why Fintech Won’t Kill Banks, The Economist Explains (June 16, 2015), http://
www.economist.com/blogs/economist-explains/2015/06/economist-explains-12 (discussing
the impact of fintech on traditional banks).
13
. See Douglas W. Arner et al., The Evolution of FinTech: A New Post-Crisis
Paradigm? 18 (2015), http://ssrn.com/abstract=2676553 (noting that fintech com-
prises the following five areas: finance / investment, operations / risk management,
payments / infrastructure, data security / monetization, and customer interface).
13
. See, e.g., Allan Ripp, You’ll Never Look at Your ATM the Same Way Again, THE
STREET (Nov. 7, 2015), http://www.thestreet.com/story/13350569/1/you-ll-never-look-at-
your-atm-the-same-way-again.html; Tarun Wadhwa, Wells Fargo Wants to Let You Make
Million-Dollar Wire Transactions with Your Face and Voice, FORBES (Nov. 3, 2015), http://
www.forbes.com/sites/tarunwadhwa/2015/11/03/why-wells-fargo-wants-to-let-you-make-
million-dollar-wire-transactions-with-your-face-and-voice/.
14
. See, e.g., Allan Ripp, You’ll Never Look at Your ATM the Same Way Again, THE
STREET (Nov. 7, 2015), http://www.thestreet.com/story/13350569/1/you-ll-never-look-at-
your-atm-the-same-way-again.html; Tarun Wadhwa, Wells Fargo Wants to Let You Make
Million-Dollar Wire Transactions with Your Face and Voice, FORBES (Nov. 3, 2015), http://
www.forbes.com/sites/tarunwadhwa/2015/11/03/why-wells-fargo-wants-to-let-you-make-
million-dollar-wire-transactions-with-your-face-and-voice/.
20 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
This transformation of the banking business is not new. As tech-
nology has evolved, so too has the business of banking.
15
Computeriza-
tion has reshaped every aspect of banking, from deposit taking to lend-
ing.
16
Securitization, derivatives, credit, debit and prepaid cards, remote,
mobile and home banking, check imaging and a world of other products
and services we now take for granted all developed because technology
permitted dramatic shifts in the way traditional banking was conducted.
17
The entry of nonbank competitors into the field of banking is not
new either. Western Union leveraged its telegram business to introduce
money transfers in the nineteenth century.
18
Securities firms are active
lenders and provide numerous deposit products through their money mar-
ket funds and other offerings.
19
More recently, PayPal and CheckFreePay
have made substantial inroads into online bill payments.
20
Green Dot,
InComm and NetSpend are significant providers of prepaid cards, which
can serve as convenient substitutes for bank deposits and debit cards for
15
. See Arner et al., supra note 13, at 10–15 (discussing the development of tra-
ditional digital financial services).
16
. See id. at 8–10.
17
. See id. at 11–12 (“By the beginning of the 21
st
century, both banks’ internal
processes, interactions with outsiders and an ever increasing number of their inter-
actions with retail customers had become fully digitized, facts highlighted by the
significance of IT spending by the financial services industry.”).
18
. WESTERN UNION, OUR RICH HISTORY, http://corporate.westernunion.com/
History.html (last visited Nov. 10, 2015). Western Union completed the first trans-
continental telegraph line across North American in 1861. Ten years later, in 1871,
Western Union introduced money transfers. Id.
19
. Money market funds are a type of mutual fund that provides investors with
the option to purchase a pool of securities that generally provides higher rates of
return than an interest-bearing bank account. See MONEY MARKET FUNDS, U.S.
SEC. & EXCH. COMM’N, https://www.sec.gov/spotlight/money-market.shtml (last
visited Nov. 19, 2015). Today, money market funds hold more than $2.9 trillion in
assets and invest in government securities, tax-exempt municipal securities and other
corporate debt securities. Id.
20
. Will Edwards, Fiserv Agrees to Acquire CheckFree for $4.4 Billion,
BLOOMBERG (Aug. 2, 2007), http://www.bloomberg.com/apps/news?pid=newsar-
chive&sid=afxJE7EGtkss&refer=home (noting that CheckFreePay’s electronic sys-
tems for online bill paying processes more than 1 billion transactions per year); Hay-
ley Tsukayama, PayPal Makes Strong Debut on Nasdaq, WASH. POST (July 20,
2015), https://www.washingtonpost.com/business/economy/paypal-makes-strong-
debut-on-nasdaq/2015/07/20/3d5ab7c6-2f29-11e5-8353-1215475949f4_story.html
(“After more than 12 years as a part of eBay, PayPal is in a strong position when it
comes to several online payment trends. That is because of not only the success of
the traditional PayPal service but also its business-focused Braintree branch and the
peer-to-peer payments app Venmo.”).
2016] NEW WINE INTO OLD BOTTLES 21
those with little or no access to traditional banks.
21
Lending Club,
OnDeck, Funding Circle and other peer-to-peer lenders are matching
willing providers of funds to borrowers in an automated fashion, promis-
ing less overhead and more efficient execution.
22
Yet, just as the entry of nonbank competitors using new technol-
ogies to capture what has traditionally been the hallowed turf of the bank-
ing industry is an oft-repeated story, so, too, is the clash between these
new entrants and the labyrinth of laws and regulations governing the busi-
ness of banking.
23
Is PayPal a bank? Does GreenDot accept deposits?
Is CheckFreePay a money transmitter? What license does Lending Club
need? Are the loans purchased from peer-to-peer lenders simply loans,
or are they securities? These questions were not trivial at the time these
companies started, and they are not trivial today for new entrants. And
while the PayPals, GreenDots and CheckFreePays of the world seem to
have reached a reasonable accommodations with the traditional banking
regulatory framework,
24
we are now watching in real time the asking and
answering of these questions as they apply to marketplace lenders, bitcoin
companies, and other new entrants into what is now commonly known as
fintech.
21
. Todd J. Zywicki, The Economics and Regulation of Network Branded Pre-
paid Cards, 65 FLA. L. REV. 1477, 1479 (2013) (“Prepaid cards are especially im-
portant for unbanked Americans as a mechanism for electronic payments and as an
alternative to traditional bank accounts.”).
22
. See, e.g., Carney, supra note 12; Kevin Wack, OnDeck Swings to Profit as
its Marketplace Business Booms, AM. BANKER, Nov. 2, 2015.
23
. See generally Jill Andersen Hill, Virtual Currencies & Federal Law, 18 J.
CONSUMER & COMM. L. 65 (2014) (discussing application of criminal law, tax law,
banking law, securities law and consumer protection law to virtual currencies); Reu-
ben Grinberg, Bitcoin: An Innovative Alternative Digital Currency, 4 HASTINGS SCI.
& TECH. L.J., 159 (2011) (discussing application of federal law and securities regu-
lation to bitcoin).
24
. For example, PayPal is licensed as a money transmitter on a state-by-state
basis. For a list of PayPal state licenses, see PAYPAL, PAYPAL STATE LICENSES,
https://www.paypal.com/webapps/mpp/licenses (last visited Nov. 10, 2015). See
also Stacy Forster, PayPal’s Woes Lead to Calls for More Industry Regulation,
WALL ST. J. (Apr. 8, 2002), http://www.wsj.com/articles/SB1018038560564846640
(noting PayPal’s position that it is a “money service” that has traditionally been reg-
ulated at the state level). Likewise, GreenDot is a licensed money transmitter in 39
states, Puerto Rico, and Washington, D.C. GREENDOT CORP., 2014 ANNUAL
REPORT 7 (Mar. 2, 2015). However, GreenDot also operates a state-chartered Fed-
eral Reserve member bank in order to provide certain mobile banking and prepaid
card services. Id. at 2. Additionally, CheckFreePay operates as a licensed money
transmitter in New York. CHECKFREEPAY, TERMS, https://www.checkfreepay.com/
info/terms (last visited Nov. 19, 2015).
22 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
This article provides an overview of what non-regulated technol-
ogy companies can expect as they seek to provide financial services in
the United States. These companies and their investors are walking into
a thicket of laws and regulations that ostensibly touch their businesses,
and regulators are struggling to determine how these new companies fit
into existing legal and regulatory regimes, most of which were designed
for a totally different world.
25
This article will address fintect meeting the world of bank regu-
lation by discussing the issues in a somewhat unique way. First, this ar-
ticle addresses the business of taking deposits, which continues to be an
issue for any company that is holding money received from consumers
with the understanding that the funds are to be returned to the consumers
on demand or otherwise transmitted as they may subsequently direct.
Second, this article addresses the issues posed by peer-to-peer or market-
place lenders, which implicate both lending licenses and, in a very im-
portant way, the securities laws. Third, this article turns to digital curren-
cies, which provide the platform for addressing money transmission
licenses, Bank Secrecy Act (“BSA”) and anti-money laundering
(“AML”) concerns, the Office of Foreign Assets Control (“OFAC”) is-
sues and additional securities or commodities law concerns. Fourth, this
article addresses the issues associated with third-party outsourcing by
banks and those companies providing ongoing services to banking organ-
izations. Lastly, this article discusses the risks that new fintech compa-
nies face when launching without a thoughtful consideration of regula-
tory compliance requirements.
The divisions are not clean and neat. A marketplace lender may
have issues with OFAC or BSA requirements, just as a digital currency
participant may inadvertently trip over securities law issues (as, indeed,
some have). It is hoped that this article will provide a useful context for
presenting and understanding these issues.
26
25
. There are, of course, very important and closely related issues, which will
not be explored in this article. Banking organizations are subject to this thicket of
laws and regulations, many of which govern what they can and cannot do. As banks
seek to exploit evolving technologies to better serve their customers, they in turn
must grapple with how far they can go. Limitations on permissible activities at the
bank or holding company levels, the Volcker rule and the limits of the merchant
banking authority all provide some constraints on how banks can permissibly ex-
plore and exploit the rapidly evolving technology area. That, however, will be an
article for another day.
26
. See, e.g., BTC Trading, Corp., Exch. Act Release No. 73783 (Dec. 8, 2014)
2016] NEW WINE INTO OLD BOTTLES 23
II. FINTECH MEETS THE BANK REGULATORY WORLD
A. Regulation of the Business of Taking Deposits
One of the core activities of banks is taking deposits, which is an
activity that is limited strictly to banks under federal and state bank stat-
utory and regulatory regimes.
27
Generally, a deposit is defined as includ-
ing checking and savings accounts and excludes certain investment prod-
ucts such as mutual funds.
28
A deeper dive into one state’s banking laws illustrates how the
business of taking deposits is regulated. For example, Georgia law de-
fines a bank as an entity “authorized to engage in the business of receiv-
ing deposits withdrawable on demand or deposits withdrawable after
stated notice or lapse of time.”
29
Georgia law also contains the common
and straightforward proposition that essentially only banks are authorized
to engage in the business of accepting deposits:
No person or corporation may lawfully engage in this
state in the business of banking or receiving money for
deposit or transmission or lawfully establish in this state
(sanctioning a computer programmer for operating two unregistered online venues
that traded securities using virtual currencies).
27
. The National Bank Act provides that deposit taking is part of the business of banking
and one of the key powers of a bank. 12 U.S.C. § 24 (Seventh) (2008). Similarly, state
chartering laws also have provisions that only permit a chartered commercial bank to accept
deposits while excluding any other corporations or businesses from doing so. See, e.g., N.Y.
BANKING LAW § 96 (McKinney 2015) (providing that only banks may hold consumer depos-
its); OHIO REV. CODE ANN. § 1109.5(A) (West 2015) (providing that a bank may receive de-
posits); TEX. FINANCE CODE ANN. § 31.002(4) (West 2015) (defining banking as an activity
that involves accepting deposits).
28
. Under the FDIC’s regulations, a deposit generally includes money held in checking,
negotiable order of withdrawal (“NOW”), savings, and money market deposit accounts, and
other items such as certificates of deposits, and does not include certain investment products
such as annuities, mutual funds, stocks, bonds, government securities, municipal securities
and U.S. treasury securities. FED. DEPOSIT INS. CORP., INSURED OR NOT INSURED?, https://
www.fdic.gov/deposit/covered/notinsured.html (last visited Nov. 17, 2015).
29
. GA. CODE ANN. § 7-1-4 (West 2015). See also 12 U.S.C. § 1813(a)(2) (2011) (The
Federal Deposit Insurance Act defines a State Bank as “any bank, banking association, trust
company, savings bank, industrial bank (or similar depository institution which the Board of
Directors finds to be operating substantially in the same manner as an industrial bank), or
other banking institution which . . . is engaged in the business of receiving deposits, other than
trust funds (as defined in this section).”).
24 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
a place of business for such purpose, except a bank, a na-
tional bank, a credit union . . ., a licensee engaged in sell-
ing checks . . ., an international banking agency . . ., a
building and loan association . . ., or a savings and loan
association . . . .
30
As the Georgia example reflects, accepting funds from the public
with a promise to make them available to the depositor brings one
squarely within the definition of a bank, while doing so without a banking
charter invites (at a minimum) regulatory scrutiny. An entity must either
be a bank, and obtain a banking license with the attendant regulation, or
look for a permissible exemption from the licensing requirement.
There are a multitude of financial activities that seem so incredi-
bly convenient that we hardly think about the consequences. For exam-
ple, when we “load” our accounts at PayPal, is PayPal accepting a de-
posit?
31
If we load or reload a prepaid card, is that a deposit?
32
If we
initiate a person-to-person transfer using our phone, and it results in a
debit to our bank account or credit card, is the entity holding the funds
until delivered holding a deposit?
33
If these funds are deposits, are they
insured by the Federal Deposit Insurance Corporation (“FDIC”)?
34
If de-
posits, are the funds subject to the Federal Reserve’s reserve require-
ments?
35
If the entity accepting the deposits is a bank, is it subject to
30
. GA. CODE ANN. § 7-1-241 (West 2015). Some of the state banking laws provide that
if an entity is not a bank, it may not accept deposits. See, e.g., CAL. FINANCE CODE § 1044
(West 2015) (providing that a bank may not conduct any business, which includes taking
deposits, until approved to do so); TEX. FINANCE CODE ANN. § 31.004 (West 2015) (prohibit-
ing a person other than a depository institution from conducting the business of banking in
Texas).
31
. For a discussion of the laws regulating the taking of deposits, see supra text accom-
panying notes 27–30.
32
. See id.
33
. See id.
34
. The Federal Deposit Insurance Act established the FDIC, which is an independent
agency that protects the funds depositors place in banks and savings associations. FED.
DEPOSIT INS. CORP., UNDERSTANDING DEPOSIT INSURANCE, https://www.fdic.gov/deposit/de-
posits/ (last visited Nov. 19, 2015). See 18 U.S.C. § 1813(m)(1).
35
. See FED. RES., RES. REQUIREMENTS, http://www.federalreserve.gov/monetarypolicy/
reservereq.htm#table1 (last visited Nov. 19, 2015) (listing the required amount of funds that
a depository institution must hold in reserve against specified deposit liabilities). For exam-
ple, these funds could be subject to the Federal Reserve Regulations E, 12 C.F.R. § 205
(2015), which governs electronic fund transfers, or Regulation CC, 12 C.F.R. § 229 (2015),
which governs the availability of funds and the collection of checks.
2016] NEW WINE INTO OLD BOTTLES 25
branching restrictions?
36
And, if the deposits are accepted at a third-party
location (a grocery store, drug store or convenience store), are those lo-
cations branches?
37
If Coinbase is holding bitcoins or Microsoft is hold-
ing Microsoft points for its users, are they taking deposits in a way that
requires them to be licensed as banks?
Of course, once an organization is deemed to be a bank, the full
weight of the seemingly endless panoply of banking laws and regulations
come crashing down and become applicable.
38
Licensing, capital re-
quirements, community reinvestment obligations, truth in lending, truth
in savings, equal credit opportunity and an almost endless list of other
statutes and regulations can become part of an organization’s life.
39
These are all wonderful and interesting questions, and at least for
now the tentative answer appears to be that, with respect to dollar and
other fiat currency-denominated funds, if you properly structure, docu-
ment and disclose your relationships, you can avoid the banking re-
strictions.
40
As a general proposition, unless an entity is already a char-
tered bank, it must place customer funds in another insured depository
institution under a structure that indicates that the entity is not the
“owner” of the funds, but rather that the funds are being placed on behalf
of itscustomers.
41
If this approach is followed, the entity should be able
36
. Interstate branching restrictions on national banks ability to branch across state lines
are very limited. See generally John C. Dugan et al., Forms of Entry, Operation, Expansion
and Supervision of Foreign Banks in the United States, REGULATION OF FOREIGN BANKS &
AFFILIATES IN THE UNITED STATES 18 (2014) (Randall D. Gyunn ed., 2014) (discussing the
lack of restrictions on the ability of banks to branch across state lines). Some state bank
regulatory regimes place restrictions on interstate branching. See generally RONALD L.
SPIEKER, FUTURE OF BANKING STUDY: BANK BRANCH GROWTH HAS BEEN STEADY—WILL IT
CONTINUE? 3 (2004).
37
. Often different state banking laws define branch in different ways. See, e.g., N.C.
GEN. STAT. § 53C-1-4 (providing the definition of a branch under North Carolina’s banking
law); TEX. FINANCE CODE ANN. § 31.002 (a)(8)(2015) (providing the definition of a branch
under Texas banking law).
38
. For a list of federal banking regulations, see BD. OF GOVERNORS OF THE FED. RES.
SYSTEM, REGS., http://www.federalreserve.gov/bankinforeg/reglisting.htm (last updated July
27, 2015); FED. DEPOSIT INS. CORP., FED. DEPOSIT INS. CORP. LAW, REGS., RELATED ACTS,
https://www.fdic.gov/regulations/laws/rules/2000-50.html (last updated Sept. 30, 2014).
39
. For a list of banking regulations, see id.
40
. In the United States, banks are subject to both federal and state banking laws. It is
possible for fintech firms to not engage in certain activities, such as taking deposits or making
loans, in order to avoid being regulated as a bank. See Rys Bollen, infra note 43 (explaining
that if a bitcoin company engages in certain activities such as accepting customer funds and
making loans the banking laws in some states may be implicated).
41
. For example, PayPal received an advisory opinion from the FDIC in 2002, stating
that PayPal may not hold customer funds because it is not a bank. FED. DEPOSIT INS. CORP.
26 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
to avoid classification as a bank with all the attendant consequences.
42
Intent and disclosure play a big role in determining banking status, and
having an insured depository institution in the chain is very helpful for
avoiding that characterization. Additionally, banking agencies have not
yet found that bitcoins, gaming points, rewards points or similar digital
or virtual currencies should be considered deposits, although they are reg-
ulated in other ways, as described in more detail below.
43
B. Peer-to-Peer or Marketplace Lenders
We have witnessed an explosion in online lenders such as Pros-
per, Lending Club, and SoFi.
44
As of 2014, peer-to-peer platforms had
issued $5.5 billion of loans in the United States, and it is estimated that
the total amount of loans issued through 2025 will exceed $150 billion.
45
Advisory Opinion, 2002 FDIC Interp. Ltr. LEXIS 40 (Feb. 15, 2002). PayPal’s name was
later redacted, but news articles at the time confirm that PayPal was the subject of this advi-
sory opinion. See Deborah Bach, CEO Insists PayPal Will Not Be Declared a Bank, AM.
BANKER, Mar. 19, 2002 (quoting the language from the FDIC’s advisory opinion); see also
Feds: PayPal Is Not a Bank, CNET (May 19, 2002), http://www.cnet.com/news/feds-paypal-
not-a-bank/ (quoting language from the FDIC’s advisory opinion). As a result, PayPal began
to keep balances left in customer accounts in FDIC-insured bank accounts. Id. PayPal dis-
closes on its website that it uses partner banks such as Bank of America, Citibank, HSBC
Bank USA, RBS Citizens Bank and Wells Fargo Bank to actually hold its customers’ funds.
FDIC-Insured Banks, PAYPAL, https://www.paypal.com/cgi-bin/webscr?cmd=p/pop/
fdic_banks-outside (last visited Nov. 16, 2015).
42
. In PayPal’s case, PayPal was able to avoid being classified as a bank by placing cus-
tomer funds in a bank. Feds: PayPal Is Not a Bank, supra note 41.
43
. See Rys Bollen, The Legal Status of Online Currencies: Are Bitcoins the Future? 31–
32 (2013), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2285247 (explaining that if a
bitcoin company engages in certain activities such as accepting customer funds and making
loans then the banking laws in some states may be implicated). At the time this article was
written, no state or federal regulator has taken the view that a business that holds bitcoins or
other digital currencies for others is taking deposits, although other nonbank regulatory re-
gimes may be implicated, which will be discussed later in this article.
44
. See Matt Scully & Tracy Alloway, People Have Some Interesting Thoughts About
Peer-to-Peer Lending, BLOOMBERG BUS., Oct. 29, 2015, http://www.bloomberg.com/news/
articles/2015-10-29/people-have-some-interesting-thoughts-about-peer-to-peer-lending (not-
ing that the peer-to-peer lending industry is quickly growing). The U.S. Department of the
Treasury (“Treasury”) is monitoring this expanding industry. In early 2015, Treasury re-
quested additional information on the industry. In October 2015, at a marketplace lending
conference, Treasury noted that it was still analyzing the responses received. Of note, the
American Bankers Association and Consumer Bankers Association both highlighted that
peer-to-peer lenders face a lighter regulatory burden than banks, noting that “[c]urrently al-
ternative lenders have little regulatory oversight.” See id.
45
. PRICEWATERHOUSECOOPERS, PEER PRESSURE: HOW PEER-TO-PEER LENDING
PLATFORMS ARE TRANSFORMING THE CONSUMER LENDING INDUSTRY 1 (2015), http://
www.pwc.com/us/en/consumer-finance/publications/assets/peer-to-peer-lending.pdf.
2016] NEW WINE INTO OLD BOTTLES 27
This amount is still small in comparison to other small business lending;
in 2013, there were $580 billion in outstanding small business loans by
some measures.
46
These lending platforms allow borrowers to have their
loans approved faster and funds dispersed quicker than if the borrower
sought a loan from a traditional bank.
47
Referred to variously as “peer-
to-peer” lenders or “marketplace” lenders, these entities match those that
need credit with sources of funding.
48
Most of these lenders began by
focusing on a single asset class (e.g., individual consumers, small busi-
nesses, or student loans).
49
Many of these companies have enjoyed spec-
tacular growth and media hype surrounding their roles in displacing tra-
ditional bank lenders.
50
The peer-to-peer lending model is relatively straightforward. Re-
lying on various sources of data, proprietary algorithms and other tech-
nological tools, the lenders market loans to potential borrowers and
gather the necessary information to make a credit decision.
51
Once a loan
is deemed to have met necessary standards, the lender “sanitizes” the in-
formation, making it non-personally identifiable, and transmits the infor-
mation to potential funding sources.
52
The lender is responsible for doc-
umenting and servicing the loans as well as managing all aspects of the
repayment process.
53
Some lenders find lendable funds from individuals
46
. SMALL BUS. ASSOCIATION, SMALL BUSINESS LENDING IN THE UNITED STATES IN 2013
(2013) (defining small business loans as loans of $1 million or less).
47
. Id.
48
. See Scully & Alloway, supra note 44 (noting that the peer-to-peer lending industry
is quickly growing).
49
. For example, Lending Club focuses on personal and business loans, while SoFi began
by offering student loan refinancing. See LENDING CLUB, https://www.lendingclub.com/ (last
visited Nov. 10, 2015). Today, SoFi also offers personal loans and mortgages. See SOFI,
https://www.sofi.com/ (last visited Nov. 10, 2015).
50
. See generally Maureen Farrell, Investors Like Lending Club’s Growth, WALL ST. J.
(Aug. 5, 2015), http://blogs.wsj.com/moneybeat/2015/08/05/investors-like-lending-clubs-
growth/; Zachary Karabell, The Uberization of Money, MoneyBeat Blog WALL ST. J. (Nov.
6, 2015), http://www.wsj.com/articles/the-uberization-of-finance-1446835102; Scully & Al-
loway, supra note 44.
51
. See From the People, For the People: But will financial democracy work in a down-
turn?, ECONOMIST (May 9, 2015), http://www.economist.com/news/special-report/
21650289-will-financial-democracy-work-downturn-people-people.
52
. See id. Both Lending Club and Prosper include a privacy note on their websites,
stating that they protect the privacy of the borrower and the investors by never revealing a
party’s actual identity. How does an online credit marketplace work?, LENDING CLUB, https:/
/www.lendingclub.com/public/how-peer-lending-works.action (last visited Nov. 10, 2015);
Peer-to-Peer Lending Means Everyone Prospers, PROSPER, https://www.prosper.com/wel-
come/how_it_works.aspx (last visited Nov. 10, 2015).
53
. For example, Lending Club describes the peer-to-peer lending process as follows: (1)
28 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
willing to take risks and provide credit, while others look to banks or
other institutional investors.
54
Many lenders partner with banks toorigi-
nate the loan, attempting to take advantage of certain legal protections
and immunities that banks enjoy.
55
All lenders attempt to automate the
customer acquisition, underwriting and lending process to achieve econ-
omies and advantages that traditional banks cannot.
56
Regardless of how
they are structured or operated, these marketplace lending companies are
a growing force in our financial system.
57
1. Federal Regulation of Consumer Lending
Most federal lending requirements are designed to protect con-
sumers—the Truth in Lending Act,
58
the Equal Credit Opportunity Act,
59
the Fair Housing Act,
60
the Real Estate Settlement Procedures Act
(“RESPA”),
61
the Fair Credit Reporting Act,
62
the Gramm-Leach-Bliley
Act (“GLBA”) privacy provisions
63
—the list is long and growing, and
each new regulation represents a significant compliance obligation.
customers interested in a loan complete and submit an application to LendingClub.com; (2)
Lending Club uses online data and technology to assess risk, determine a credit rating and
assign interest rates; and (3) investors select the loan in which to invest and earn monthly
returns. How does an online credit marketplace work?, supra note 52. Prosper describes its
process as follows: (1) borrowers chose a loan amount and purpose and post a loan listing; (2)
investors view the loan listings and invest in listings of interest; and (3) once the process is
complete, borrowers make monthly payments and investors receive a portion of the payments.
Peer-to-Peer Lending Means Everyone Prospers, supra note 52. See also From the People,
For the People: But will financial democracy work in a downturn?, supra note 51.
54
. See From the People, For the People: But will financial democracy work in a down-
turn?, supra note 51 (noting that most of the funding for peer-to-peer lending no longer comes
from the general public but instead comes from institutional investors).
55
. “Small local lenders in America have turned to peer-to-peer marketplaces to gain
exposure to consumer credit; Citigroup said in April that it would lend $150m through Lend-
ing Club.” Id., see also, PWC, PEER PRESSURE: HOW PEER-TO-PEER LENDING PLATFORMS ARE
TRANSFORMING THE CONSUMER LENDING INDUSTRY 2 (Feb. 2015) (“Banks and institutional
investors are buying blocks of P2P loans to add to their portfolios.”).
56
. See generally From the People, For the People: But will financial democracy work
in a downturn?, supra note 51; PWC, PEER PRESSURE, supra note 55.
57
. From the People, For the People: But will financial democracy work in a downturn?,
supra note 51.
58
. Truth in Lending Act, 12 C.F.R. § 1026 (2012).
59
. Equal Credit Opportunity Act, 12 C.F.R. § 202 (2012).
60
. Discriminatory Conduct Under the Fair Housing Act, 24 C.F.R. § 100 (2010).
61
. Real Estate Settlement Procedures Act, 24 C.F.R. § 3500 (2010).
62
. Fair Credit Reporting Act, 12 C.F.R. § 1022.1 (2012).
63
. Privacy of Consumer Financial Information, 16 C.F.R. § 313 (2012).
2016] NEW WINE INTO OLD BOTTLES 29
Many of the statutes are directed to “creditors” (e.g., Truth in Lending)
and apply to those engaged in the business of extending credit.
64
Others
apply to “financial institutions” (e.g., GLBA-privacy provisions) and en-
tities engaged in activities that are permissible for banks and bank holding
companies.
65
It is important to note that applicability of the laws is more
often defined by the activities an entity engages in, rather than by an en-
tity’s charter. If an entity extends consumer credit, it is subject to the
Truth in Lending Act.
66
If an entity is engaged in an activity a bank or
bank holding company may engage in with individuals, it will have
GLBA-privacy obligations.
67
Thus, many of these laws and regulations
apply to lenders of all types, not just for those defined as “banks” at their
founding.
There is very little federal regulation of non-consumer lending.
For example, there is no federal interest rate or usury cap,
68
and the Truth
in Lending Act does not apply to loans extended primarily for business,
commercial or agricultural purposes or credit extended to an entity other
than a natural person.
69
The Fair Credit Reporting Act relates to con-
sumer credit, not commercial credit.
70
The provisions of Section 5 of the
64
. For example, Regulation Z, the regulation implementing the Truth in Lending Act,
covers persons and businesses that offer or extend credit (1) to consumers, (2) on a regular
basis, (3) payable under a written agreement in more than four installments, and (4) primarily
for personal, family or household purposes. 12 C.F.R. § 1026.1(c) (2015).
65
. The GLB privacy provisions “govern[] the treatment of nonpublic personal infor-
mation about consumers by the financial institutions . . . .” Privacy of Consumer Financial
Information § 313(a). The scope of the regulation applies to, but is not limited to, “mortgage
lenders, ‘pay day’ lenders, finance companies, mortgage brokers, account servicers, check
cashers, wire transferors, travel agencies operated in connection with financial services, col-
lection agencies, credit counselors and other financial advisors, tax preparation firms, non-
federally insured credit unions, and investment advisors that are not required to register with
the Securities and Exchange Commission.” Privacy of Consumer Financial Information §
313(b).
66
. See Truth in Lending Act § 1026.1(c) (2012) (noting that generally the Truth in Lend-
ing Act applies to “each individual or business that offers or extends credit”).
67
. Privacy of Consumer Financial Information § 313.
68
. See Nathalie Martin, Public Opinion and the Limits of State Law: The Case for a
Federal Usury Cap, 34 N. ILL. U. L. REV. 259 (2014) (arguing for a federal interest rate cap
of 36%).
69
. See Truth in Lending Act § 1026.3(a) (exempting an extension of credit primarily for
a business, commercial or agricultural purpose or an extension of credit to other than a natural
person from the requirements of the Truth in Lending Act).
70
. See Fair Credit Reporting Act § 1022.1(a) (2012) (“This part generally applies to
persons that obtain and use information about consumers to determine the consumer’s eligi-
bility for products, services, or employment, share such information among affiliates, and
furnish information to consumer reporting agencies.”).
30 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
Federal Trade Commission Act, empowering the Federal Trade Commis-
sion (“FTC”) to “prevent persons, partnerships, or corporations . . . from
using . . . unfair or deceptive acts or practices in or affecting commerce”,
have no such limitation, although virtually all FTC enforcement actions
are focused on consumer abuses.
71
The Consumer Financial Protection
Bureau, established by the Dodd-Frank Act was specifically established,
as its name indicates, to protect consumers from abusive, deceptive or
unfair financial products.
72
2. State Regulation of Lending
Regulation of lending at the state level is every bit as complicated
and difficult as at the federal level, and perhaps more so as there are a
multitude of jurisdictions. Traditionally each state has established inter-
est and usury laws and regulations that limit the interest rates and fees
that can be charged by lenders.
73
A. INTEREST AND USURY LAWS
The concept of protecting consumers from interest is an ancient
one, with references in Exodus, Leviticus, and Deuteronomy of the Old
71
. Section 5(a)(2) of the Federal Trade Commission Act. See generally Timothy J. Mu-
ris, The Federal Trade Commission and the Future Development of U.S. Consumer Protection
Policy, COLUM. BUS. L. REV. 359, 386 (2003) (discussing the FTC’s consumer protection role
and how it fits into the modern consumer protection regime).
72
. Title X of the Dodd-Frank Act, entitled the Consumer Financial Protection
Act of 2010, established the Consumer Financial Protection Bureau (“CFPB”).
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub.L. No.
111-203, 124 Stat. 136. The rules implementing Dodd-Frank provide that the pur-
pose of the CFPB is to “seek to implement and, where applicable, enforce Federal
consumer financial law consistently for the purpose of ensuring that all consumers
have access to markets for consumer financial products and services and that mar-
kets for consumer financial products and services are fair, transparent, and compet-
itive.” 12 U.S.C. § 5511(a) (2015).
73
. See Martin, supra note 68, at 263 (“In the U.S., usury laws have historically been the
main protection consumers have had against harsh credit practices.”).
2016] NEW WINE INTO OLD BOTTLES 31
Testament.
74
Every state has an interest and usury statute.
75
While there
are often various exceptions to the statutes (e.g., commercial loans, loans
above a specified amount, or credit card loans), the interest rates pre-
scribed can be quite low, occasionally ranging from five to ten percent.
76
However, determining which state’s interest and usury laws ap-
ply can be difficult at times. There is an initial presumption on the part
of a state that a loan made to a resident of a state will be subject to that
state’s particular laws. Choice-of-law provisions in contracts may be
helpful in selecting another state’s laws to govern a transaction, but typi-
cally in the consumer context, the chosen state must bear some substantial
relationship to the transaction.
77
Banks may have the ability to choose a
state with liberal interest and usury laws by locating their lending deci-
sions in such states, and generally can export their home state’s usury
limits to other states where they extend loans or issue credit.
78
This al-
lows banks to charge high interest rates on consumer credit card debt be-
cause the interest rate can exceed the usury limit of the state where the
74
. See Thomas Moser, The Old Testament Anti-Usury Laws Reconsidered: The Myth of
Tribal Brotherhood (1997), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=41844 (dis-
cussing the development of the anti-usury laws of the Hebrew Bible). While chapter 22:24
of the Book of Exodus prohibits the taking of interest, chapter 25:35 of the Book of Leviticus
prohibits the taking of interest from those in economic distress. Interestingly, chapter 23:19–
20 of Deuteronomy prohibits the taking of interest from the Jewish community but not from
foreigners. Id.
75
. See Christopher L. Peterson, Usury Law, Payday Loans, and Statutory Sleight of
Hand: Salience Distortion in American Credit Pricing Limits, 92 MINN. L. REV. 1110, 1114
(2008) (providing an empirical analysis of all fifty states’ usury laws).
76
. See, e.g., ALA. CODE § 8-8-1 (2015) (providing that the legal rate of interest is 8%);
Cal. Const., Art. XV § 1 (2012) (providing that the legal interest rate is 7% to 10% for con-
sumers depending on the type of loan or forbearance); COLO. REV. STA. ANN. § 5-12-101
(West 2015) (providing that the legal rate of interest is 8%); CONN. GEN. STAT. § 37-1 (2015)
(providing that the legal rate of interest is 8%); DEL. CODE ANN. tit. 6 § 2301 (providing that
the legal interest rate is 5%); D.C. Code Ann. § 28-3302 (West 2015) (providing that the legal
rate of interest is 6%); GA. CODE ANN. § 7-4-2 (West 2015) (providing that the legal rate of
interest is 7%); 815 ILL. COMP. STAT. § 205/1 (West 2015) (providing that the legal rate of
interest is 5%); IOWA CODE § 535.2 (2014) (providing that the legal rate of interest is 5%);
ME. REV. STAT. ANN. tit. 9-B § 432 (2015) (providing that the legal rate of interest is 6%); 41
PA. CODE § 202 (2015) (providing that the legal interest rate is 6%).
77
. See RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 187 cmt. f at 5 (1971) (“When
the state of the chosen law has some substantial relationship to the parties or the contract, the
parties will be held to have had a reasonable basis for their choice.”).
78
. Traditional banks have relied upon the ability to export interest and fees pursuant to
12 U.S.C. § 85 (2015) and 12 U.S.C. § 1831d(a) (2015). Non-bank lenders do not enjoy this
privilege. See also BARKLEY CLARK ET AL., COMPLIANCE GUIDE TO PAYMENT SYSTEMS: LAW
AND REGULATION § 12.16[2] (2014) (providing a discussion of state usury laws and a bank’s
ability to export its home state usury limit).
32 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
consumer resides.
79
Nonbank lenders have much less flexibility in that
regard as they aren’t entitled to the benefits of the federal banking stat-
utes, so many have paired with traditional bank lenders.
80
The feasibility
of using a bank partner is discussed in section c below.
B. LENDER LICENSING
Many states also require the licensing of non-bank lenders, par-
ticularly providers of consumer credit.
81
Not surprisingly, following
problems in the mortgage market during the financial crisis with abusive
lending practices, sloppy servicing and rampant defaults, there has been
a renewed interest in overseeing those involved in providing residential
mortgage credit and assuring uniform regulation, licensing and supervis-
ing of entities and individuals in the mortgage lending area.
82
State laws governing lender licensing outside the mortgage space
vary considerably. One of the critical differences relates to the extent and
nature of the activities that require licensing.
83
Variables include the loan
79
. See BARKLEY CLARK ET AL., supra, note 79 at § 12.16 (explaining that a national bank
that issues credit cards may export interest rates from its home state and charge up to the
interest rate allowed for licensed lenders in a state).
80
. Interestingly, in a recent case, the U.S. Court of Appeals for the Second Circuit re-
fused to reconsider its decision that restricts marketplace lenders from bypassing state usury
laws by pairing with banks in states that have no such rules. Madden v. Midland Funding,
LLC, 786 F.3d 246, 253–54 (2nd Cir. 2015), petition for cert. filed, 84 U.S.L.W. 675 (U.S.
Nov. 10, 2015) (No. 15-610). See infra, note 98.
81
. For examples of state licensing requirements for providers of consumer credit, see
Regulated Lenders, TEXAS OFFICE OF CONSUMER CREDIT COMMISSIONER, http://
occc.texas.gov/industry/regulated-lenders (last visited Nov. 10, 2015) (providing guidance for
becoming a regulated lender in Texas); Consumer Credit Licensing Information, MISSOURI
DIV. OF FINANCE, http://finance.mo.gov/consumercredit/licensing.php (last visited Nov. 10,
2015) (providing guidance for consumer credit licensing in Missouri); Consumer Credit,
IDFPR, http://www.idfpr.com/dfi/ccd/ccd_main.asp (last visited Nov. 10, 2015) (providing
guidance relating to consumer credit licensing and regulation in Illinois).
82
. For example, the Secure and Fair Enforcement for Mortgage Licensing Act of 2008
(“SAFE Act”) required states to pass legislation within a year of the SAFE Act being adopted
that would require the licensing of mortgage loan originators according to national standards
and the participation of state agencies on the Nationwide Mortgage Licensing System and
Registry (“NMLS”). SAFE Act, 12 U.S.C. §§ 5512, 5581, 15 U.S.C. §§ 1604(a), 1639(b).
83
. For example, the Missouri Division of Finance divides its licensing categories into
nine different types of activities, ranging from consumer installment lenders to title lenders.
Consumer Credit Licensing Information, supra note 81. The Florida Division of Consumer
Finance divides its consumer licensing categories into six different activities, including col-
lection agencies, loan originators, retail installment sales and title loan companies. Welcome
to the Division of Consumer Finance, FLORIDA OFFICE OF FINANCIAL REGULATION, http://
www.flofr.com/StaticPages/DivisionOfConsumerFinance.htm (last visited Nov. 12, 2015).
2016] NEW WINE INTO OLD BOTTLES 33
amounts covered by the state statute, the number of loans that may be
made within the state without licensing, and so on. Most state licensing
schemes require information on the lender, its officers and directors and
any significant shareholders or owners of the lender.
84
In the mortgage lending arena, the licensing requirements are
much more uniform due to the Secure and Fair Enforcement for Mortgage
Licensing, or SAFE Act, passed in 2011.
85
While it does not supplant
state law requirements, the SAFE Act requires federal registration for
mortgage loan originators, and piggybacks on the NMLS, a system de-
veloped by the Conference of State Bank Supervisors (“CSBS”) and the
American Association of Residential Mortgage Regulators for the state
licensing and registration of mortgage loan originators.
86
The advent and
sanction of the registry have caused the licensing requirements to become
much more uniform.
87
These requirements include specific background
checks as well as the reporting of other information designed to assure a
safe and sound industry.
88
Individual states may have separate require-
ments. For instance, in North Carolina, mortgage servicers are required
to register and be licensed under the North Carolina version of the SAFE
Act.
89
84
. For example, the Missouri Division of Finance applications typically require the com-
pany name, address, hours of operation, contact information, the names and titles of partners
or officers if the entity is a partnership or corporation, and whether the requesting entity holds
any other consumer credit licenses in the State of Missouri. See Section 408.500 Small, Small
Loan Company Licensing Application Packet, MISSOURI DIV. OF FIN., http://finance.mo.gov/
Contribute%20Documents/500ApplicationPacket2015.pdf (last visited Nov. 13, 2015). Vir-
ginia requires information on the company, its business activities both in Virginia and out of
state, ownership information of each director, senior officer, member, trustee and partner, as
well as three business references. Application for a Consumer Finance License Pursuant to
Chapter 15 of Title 5.2 of the Code of Virginia, CCB-4401 (Rev. 05-13), COMMONWEALTH OF
VA. STATE CORP. COMM’N, https://www.scc.virginia.gov/publicforms/68/ccb4402.pdf (last
visited Nov. 11, 2015).
85
. SAFE Act §§ 5512, 5581.
86
. SAFE Act §§ 5512, 5581; see generally Resource Center, NMLS, http://mortgage.na-
tionwidelicensingsystem.org/Pages/default.aspx (last visited Nov. 12, 2015).
87
. Indeed, the SAFE Act specifically states that, among other things, its purpose is to
“increase uniformity” and provide “uniform license applications and reporting requirements
for State-licensed loan originators.” SAFE Act § 5101.
88
. Section 1504(a) requires background checks in connection with an application to any
state for licensing and registration as a state-licensed loan originator. The background checks
include: (1) fingerprints for submission to the Federal Bureau of Investigation; and (2) a per-
sonal history and authorization to obtain (a) an independent credit report and (b) information
related to any administrative, civil or criminal finding.
89
. North Carolina Secure and Fair Enforcement Mortgage Licensing Act, N.C. Gen.
34 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
Without attempting to explore all of the nuances of the interplay
between these state regulatory schemes and their applicability to feder-
ally-chartered banks (particularly national banks), note that for the pur-
poses of this article, virtually all of the state licensing systems exclude
banks from the scope of coverage. The general theory of exemption is
that banks are already subject to a system of comprehensive regulation,
and there is no need to overlay another regulatory system of licensing and
reporting.
90
And while banks are not exempt from interest and usury laws
imposed by a state, a well-developed body of case law exists to the effect
that a bank is entitled avail itself of the interest and usury laws of the state
where it is deemed to make a loan, providing a “locus” that may be diffi-
cult for an Internet-based lender without a physical presence to dupli-
cate.
91
3. Bank Partners of Marketplace Lenders
To avoid the state-by-state interest and usury restrictions,
92
or to
avoid the state-by-state licensing requirements with their attendant diffi-
culties,
93
nonbank lenders will often partner with regulated banks.
94
The
Stat. § 53.244 (2009) (requiring individuals and companies who engage in the mortgage busi-
ness in North Carolina to be licensed by the Commissioner of Banks).
90
. See, e.g., Watters v. Wachovia Bank, 550 US 1 (2007) (“In the years since the NBA’s
enactment, we have repeatedly made clear that federal control shields national banking from
unduly burdensome and duplicative state regulation.”).
91
. See 12 U.S.C. § 85 (“Any association may take, receive, reserve, and charge on any
loan or discount made, or upon any notes, bills of exchange, or other evidences of debt, inter-
est at the rate allowed by the laws of the State, Territory, or District where the bank is lo-
cated . . . and no more, except that where by the laws of any State a different rate is limited
for banks organized under State laws, the rate so limited shall be allowed for associations
organized or existing in any such State under title 62 of the Revised Statutes.”); see also Mar-
quette Nat. Bank v. First of Omaha Corp., 439 U.S. 299 (1978) (holding that pursuant to 12
U.S.C. § 85 a national bank may charge interest on any loan at the rate allowed by the state
in which the bank is located).
92
. JAMES SIVON ET AL., UNDERSTANDING FINTECH AND BANKING LAW: A PRACTICAL
GUIDE 88 (2014).
93
. Kevin Tu, Regulating the New Cashless World, 65 ALA. L. REV. 77, 86–88, 92
(2013).
94
. KEVIN TAYLOR, FINTECH LAW: A GUIDE TO TECHNOLOGY LAW IN THE FINANCIAL
SERVICES INDUSTRY § 5.III.C.2 (2014). See also W. Scott Frame, Marketplace Lending’s Role
in the Consumer Credit Market, FED. RESERVE BANK OF ATLANTA: CTR. FOR FIN. INNOVATION
AND STABILITY (Sept. 2015), https://www.frbatlanta.org/cenfis/publications/
notesfromthevault/1509 (“Having a partner bank allows the marketplace lender to: (1) pur-
chase the loans without needing to obtain individual state banking/lending licenses; and (2)
charge interest rates that are legal in the partner bank’s state but may not be in the borrowers’
2016] NEW WINE INTO OLD BOTTLES 35
bank, typically located in a state with favorable interest rates such as
Utah, South Dakota or Delaware, will be the original party to the loan.
95
The nonbank lender will market to the borrower, and using credit stand-
ards established by the bank and agreed to by the non-bank lender, will
process the loan. The bank itself will make the loan, but the non-bank
lender will subsequently purchase the loan, normally within a few days
after the loan has closed.
96
Following the purchase, the nonbank lender
will service the loan.
97
This type of arrangement quickly became standard in the market-
place.
98
As the bank was the entity actually extending credit, the fact that
a nonbank entity marketed, purchased and serviced the loan after it was
made was not sufficient to challenge the lender’s right to rely on the pro-
tections afforded banks under state laws.
99
Recently, market practice was
state.”).
95
. W. Scott Frame, Marketplace Lending’s Role in the Consumer Credit Market, FED.
RESERVE BANK OF ATLANTA: CTR. FOR FIN. INNOVATION AND STABILITY (Sept. 2015), https://
www.frbatlanta.org/cenfis/publications/notesfromthevault/1509. UTAH CODE ANN. § 15-1-1
(providing 10% legal interest rate); S.D. CODIFIED LAWS §§ 54-3-5.1, 54-3-16 (providing 15%
legal interest rate); DEL. CODE ANN. tit. 6, § 2301 (West 2015) (providing a 5% plus the Fed-
eral Reserve discount rate as of the time the interest is due).
96
. Frame, supra note 95 (“Once a match occurs between a borrower and investor(s), the
loan is actually originated onto the balance sheet of a partner bank. (Both Lending Club and
Prosper use WebBank, a Utah-chartered industrial bank.) The partner bank holds loans for a
few days before selling them to the marketplace lender, which in turn sells them to inves-
tors.”).
97
. Id. (“After loan origination, marketplace lenders are responsible for servicing, which
primarily involves maintaining accounts, processing borrower payments, and distributing
funds to investors.”).
98
. Id. (“Having a partner bank allows the marketplace lender to: (1) purchase the loans
without needing to obtain individual state banking/lending licenses; and (2) charge interest
rates that are legal in the partner bank’s state but may not be in the borrowers’ state.”). There
was a large body of case law upholding this practice. See, e.g., Discover Bank v. Vaden, 489
F.3d, 594, 597 (4th Cir. 2007), rev’d on other grounds 556 U.S. 49 (2009); Krispin v. May
Department Stores Co., 218 F.3d 919 (8
th
Cir. 2000). As the Krispin court noted, “[t]he non-
usurious character of a note should not change when the note changes hands.” Id. at 924
(quoting FDIC v. Lattimore Land Corp., 656 F.2d 139, 147-149 (5
th
Cir. Unit B 1981)). How-
ever, a recent appellate court opinion unsettled this line of cases, in terms of charging interest
rates that are legal in the bank’s state, but may not be legal in the borrower’s state. In Madden
v. Midland Funding, a Second Circuit court reversed a district court’s decision, finding that
the National Bank Act did not preempt the plaintiff’s claim under New York State law usury
claims and Fair Debt Collection Practices Act because the defendant lender was not a national
bank or its subsidiary or affiliate. Madden v. Midland Funding, LLC, 786 F.3d 246, 247
(2015), petition for cert. denied, 84 U.S.L.W. ___ (U.S. May 4, 2015) (No. __-___).
99
. Frame, supra note 95 (“Having a partner bank allows the marketplace lender to: (1)
purchase the loans without needing to obtain individual state banking/lending licenses; and
(2) charge interest rates that are legal in the partner bank’s state but may not be in the borrow-
ers’ state. Notably, this second benefit of the partner bank model seems to be legally unsettled
36 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
challenged by a case brought in West Virginia where a payday lender
sought to enforce a loan purchased from a South Carolina bank. There,
based upon the facts of the arrangement, the state Attorney General
brought suit alleging that the payday lender, not the bank, was the true
lender in question. According to the Attorney General’s position, the
payday lender had issued loans without the proper license and had vio-
lated West Virginia’s interest and usury laws. Both the trial court and the
West Virginia Supreme Court of Appeals sided with the Attorney Gen-
eral, and the Supreme Court recently denied certiorari.
100
A similar case arose in North Carolina, involving a payday lender
affiliated with a lender located on an Indian reservation.
101
Despite the
defendants’ allegations that the lender was entitled to sovereign immunity
and thus North Carolina lacked any power to regulate the conduct of the
lender, the court examined the substance of the relationship between the
following a recent U.S. Appellate Court opinion.”).
100
. CashCall, Inc. v. Morrisey, 2014 W. Va. LEXIS 587 (May 30, 2014), cert. denied
CashCall, Inc. v. Morrissey, 2015 U.S. LEXIS 2991 (U.S., May 4, 2015) (No. 14-894). In
CashCall, Inc. v. Morrisey, West Virginia’s highest court, the Supreme Court of Appeals,
considered an appeal of three orders stemming from CashCall’s debt collection actions, in-
cluding state law claims of abusive debt collection and usurious lending. Id. at *1. CashCall,
a California consumer finance company, partnered with the First Bank and Trust of Millbank,
South Dakota, to issue small unsecured loans at high interest rates to consumers in various
states, including West Virginia. Id. at *2. In the initial case, the Attorney General character-
ized CashCall’s practice as a “rent-a-bank scheme” designed to avoid state usury and con-
sumer protection laws. Id. at *5. On appeal, the appeals court upheld the orders issued by
the circuit courts, which included a judgment for violations of the West Virginia Credit Pro-
tection Act. Id. at *67.
101
. North Carolina v. Western Sky Financial, LLC, 2015 NCBC LEXIS 87 (Aug. 27,
2015). In North Carolina v. Western Sky Financial, the North Carolina superior court con-
sidered a complaint against a South Dakota limited liability company operated on the Chey-
enne River Indian Reservation and whose sole owner was a member of the Cheyenne River
Sioux Tribe, but not an official or representative of the tribe’s government. Id. at *1. The
Cheyenne River Sioux Tribe did not receive any direct financial benefit from the business of
Western Sky Financial, which made consumer loans to residents of North Carolina marketed
through the company’s website and through television advertising. Id. at *5. The loans
ranged in amounts from $850 to $10,000 and charged interest rates between 89.68% and
342.86%, with repayment options ranging from 12 to 84 months. Id. at *5. The loan agree-
ments provided that agreement would be governed solely by the laws and jurisdiction of the
Cheyenne River Indian Reservation and specifically excluded the application of any U.S. state
or federal law. Id. at *7. However, shortly after a loan was approved, Western Sky Financial
sold and transferred the loan to WS Funding, LLC, a California limited liability company. Id.
at *9. The loan was serviced through a licensed mortgage lender in North Carolina, and in
some instances, the loan was sold or transferred to a licensed collection agency in North Car-
olina for servicing and collection. Id. At the time of the loans, North Carolina usury laws
provided for a maximum interest rate on North Carolina consumers on a loan of $25,000 or
less of 16% per annum. Id. at *10, *25–26.
2016] NEW WINE INTO OLD BOTTLES 37
payday lender and the nominal tribal lender and enjoined the defendants
from offering, making or collecting loans to or from North Carolina res-
idents.
102
Ultimately, the court found that the loans at issue were made
in North Carolina, rather than on the reservation, and that the court had
jurisdiction to apply North Carolina usury law.
103
A third case involves a debt collector that purchased charged-off
credit card loans from a national bank.
104
In that case, the Second Circuit
Court of Appeals reversed a district court and held that the debt collector
was not entitled to rely on the national bank’s preemption of New York
usury law where the debtor was located.
These cases have a potential to completely overturn the model
used by marketplace lenders described above. As noted, the model uses
a bank to originate the loan and, it has been thought, permit the market-
place lender as subsequent purchase to rely on the originating bank’s abil-
ity to export its interest rate and its status as a chartered bank. If those
features are lost once the bank sells the loan, the marketplace lender will
be faced with state-by-state compliance issues that will create a signifi-
cant (although not insurmountable) obstacle for the viability of the busi-
ness model.
These cases highlight that state interest in protecting its citizens
is strong, and the risks of litigation are real, especially in light of the cre-
ation of the CFPB and the ever-increasing state and federal and regulatory
interest in consumer protection.
105
While the decisions may underscore
the adage that bad cases make bad law, they also serve as a warning to
102
. Id. at *49–54.
103
. Id. at *25–26.
104
. Madden v. Midland Funding, a Second Circuit court reversed a district court’s deci-
sion, finding that the National Bank Act did not preempt the plaintiff’s claim under New York
State law usury claims and Fair Debt Collection Practices Act because the defendant lender
was not a national bank or its subsidiary or affiliate. Madden v. Midland Funding, LLC, 786
F.3d 246, 247 (2015), petition for cert. filed, 84 U.S.L.W. 675 (U.S. Nov. 10, 2015) (No. 15-
610). The court remanded the case to the district court to decide whether the Delaware choice-
of-law clause precluded the plaintiff’s claim under state and federal usury laws. Id. at 248.
In November 2015, the defendants filed a writ of certiorari to the Supreme Court, which was
pending at the time this article was written. Id.
105
. In North Carolina v. Western Sky Financial, the superior court stated that North Car-
olina has an important state interest in “protect[ing] North Carolina resident borrowers
through the application of North Carolina interest laws.” Id. at *28 (citing N.C. GEN. STAT.
§ 24-2.1(g)). See also CashCall, Inc. v. Morrisey, 2014 W. Va. LEXIS 587 (May 30, 2014),
cert. denied CashCall, Inc. v. Morrissey, 2015 U.S. LEXIS 2991 (U.S., May 4, 2015) (No.
14-894) (upholding the decision by the lower court to look through the bank making the loan
to the nonbank lender for violations of state interest and usury claims).
38 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
fintech companies that pushing the envelope can, at time, lead to unfor-
tunate results.
4. Securities Laws Applicable to Online Lenders
As noted above, Internet-based lenders have created online plat-
forms that match investors with capital with consumers seeking credit.
106
Most of the peer-to-peer lenders issue some form of pass-through notes
to their funding sources tied to the performance of the underlying
loans.
107
The U.S. Securities and Exchange Commission (“SEC”) has
determined that the notes issued by these peer-to-peer lenders to their
funding sources are securities under the federal securities laws.
108
While
some peer-to-peer lenders may sell whole loans or participations in whole
loans to their investors in an attempt to avoid this characterization, even
these whole loans or participations may be considered securities under
the securities laws.
109
Before engaging in such activities, lenders should
evaluate the loan purchaser (a sophisticated lender or investor not other-
wise principally engaged in the lending business), the method of distri-
bution (a solicitation of a wide number of unrelated investors) and the
degree of reliance on the peer-to-peer lender (how much the investor will
rely on the lender to service and administer the loans).
If the loans in which lenders participate are considered securities,
106
. Carney, supra note 22.
107
. GAO REPORT, PERSON-TO-PERSON LENDING: NEW REGULATORY CHALLENGES COULD
EMERGE AS THE INDUSTRY GROWS (July 2011), http://www.gao.gov/new.items/d11613.pdf
(“On both [the Prosper and LendingClub] platforms, lenders do not make loans directly to
borrowers. Rather, lenders purchase payment-dependent notes that correspond to the selected
borrower loans. Once lenders choose which loans to fund, WebBank, an FDIC-insured Utah-
chartered industrial bank, approves, originates, funds, and disburses the loan proceeds to the
corresponding borrowers. . . . In registering with SEC, the companies . . . now retain the
promissory notes for borrowers’ loans and sell to lenders corresponding notes, registered as
securities, that depend for their payment on borrowers’ repayment of their loans. Lenders do
not have a security interest in the loans themselves.”).
108
. See Prosper Marketplace, Inc., SEC Order No. 3-13296 (Nov. 24, 2008) (issuing a
cease-and-desist order to Prosper, an online lending platform, for violating Sections 5(a) and
(c) of the Securities Act).
109
. GAO REPORT, supra note 108 (“Although officials from Prosper and LendingClub
said that they had initially questioned the applicability of federal securities registration re-
quirements to person-to-person lending, both companies ultimately registered securities of-
ferings with SEC.”). As a general matter, whether a loan or a note is a security requires a
facts and circumstances analysis, including the economics underlying the transaction. See
Reeves v. Ernst & Young, 494 U.S. 56 (1990); Trust Co. of Louisiana v. N.P.P., 104 F.3d
1478 (5th Cir. 1997); Pollack v. Laidlaw Holdings, 27 F.3d 808 (2d Cir. 1994).
2016] NEW WINE INTO OLD BOTTLES 39
the full panoply of registration requirements or the applicability of ex-
emptions will come into play.
110
It may be possible to structure the sale
of the pass-through notes as private placements or offerings under Regu-
lation D,
111
and certain new issuers may be able to take advantage of the
crowdfunding exemption in the JOBS Act.
112
Qualification for these pro-
visions is difficult, however, and the liabilities imposed on those who fail
to register securities are high.
113
C. Digital Currencies
Digital currencies have developed as an alternative means of
transferring value from one person to another. A digital currency, such
as bitcoin, can be defined as “a digital representation of value that func-
tions as a medium of exchange, a unit of account, and/or a store of value,
but does not have legal tender status in any jurisdiction.”
114
These virtual
110
. See Prosper Marketplace, Inc., SEC Order No. 3-13296 (issuing a cease-and-desist
order to Prosper, an online lending platform, for failing to register its notes under the Securi-
ties Act); GAO REPORT, supra note 107 (providing background to the full panoply of regula-
tory challenges facing peer-to-peer lending firms).
111
. 17 CFR § 230.501 et seq.
112
. C. Steven Bradford, Crowdfunding and the Federal Securities Laws COLUM. BUS. L.
REV. 1, 7–8 (2012) (discussing the labyrinth of federal regulatory laws surrounding investor
protection and capital formation in relation to crowdfunding).
113
. Id. (“The devil is in the details. Crafting a crowdfunding exemption requires a careful
balancing of investor protection and capital formation.”). See also Daniel Forgine, How to
Finish What the JOBS Act Has Started, FORBES (Dec. 4, 2013), http://www.forbes.com/sites/
realspin/2013/12/04/how-to-finish-what-the-jobs-act-has-started/ (“Currently, due to labyrin-
thine laws, peer-lenders are unable to disintermediate banks when ‘lending’—they instead
purchase loans issued by banks in order to export uniform interest rates nationally. Peer-
lenders also face restrictions in their ability to lend to businesses, are required to register se-
curities with the SEC, and are subject to state lending laws. Moreover, although the JOBS
Act could be a potential solution for debt-based business investment given certain state and
federal law exemptions, there are other key provisions in the law that are inconsistent with
debt-based models.”).
114
. COMMODITY FUTURES TRADING COMM’N, Order, Coinflip, Inc. d/b/a Derividan, and
Francisco Riordan, CFTC Docket No. 15-29, at 2 n.2 (Sept. 17, 2015) [hereinafter CFTC
Order, Coinflip Enforcement]. For other definitions of virtual currency, see DEP’T OF
TREASURY FIN. CRIMES ENFORCEMENT NETWORK, FIN-2013-G001, GUIDANCE: APPLICATION
OF FINCEN’S REGULATIONS TO PERSONS ADMINISTERING, EXCHANGING OR USING VIRTUAL
CURRENCIES (Mar. 18, 2013) [hereinafter FINCEN, GUIDANCE ON REGULATION OF VIRTUAL
CURRENCY] (defining “virtual currency” as “a medium of exchange that operates like a cur-
rency in some environments, but does not have all the attributes of real currency”); N.Y.
COMP. CODES R. & REGS. tit. 23, § 200.2 (2015) (defining “virtual currency” as “any type of
digital unit that is used as a medium of exchange or a form of digitally stored value. Virtual
Currency shall be broadly construed to include digital units of exchange that (i) have a cen-
tralized repository or administrator; (ii) are decentralized and have no centralized repository
40 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
currencies are “distinct from ‘real’ currencies, which are the coin and pa-
per money of the United States or another country that are designated as
legal tender, circulate, and are customarily used and accepted as a me-
dium of exchange in the country of issuance.”
115
A digital currency can
function as a medium of exchange insofar as participants are willing to
accept it as payment.
116
To some extent, that willingness appears to hinge
on the ability to exchange the digital currency for legal tender when and
if necessary or desired.
Although digital currencies and participants in the digital cur-
rency ecosystem carry enormous risks,
117
many see various existing or
potential benefits, and many people are paid in and use digital currencies
in their day-to-day lives.
118
Proponents of bitcoin believe the advantages
of using bitcoin as an alternative to fiat currency is that bitcoin is faster,
cheaper, more secure than the traditional check, wire, ACH or other pay-
ment methods, with the added advantage that bitcoins are also protected
from inflation.
119
The first participants in this space—e.g., uber libertar-
or administrator; or (iii) may be created or obtained by computing or manufacturing effort.”).
See also Reuben Grinberg, The Failure of Mt. Gox and Other Recent Bitcoin Catastrophes:
Why Banks Should Care, DAVIS POLK: CAPITAL AND PRUDENTIAL STANDARDS BLOG (Mar. 7,
2014), http://blog.usbasel3.com/the-failure-of-mt-gox-and-other-recent-bitcoin-catastrophes-
why-banks-should-care/ (noting that cryptocurrencies, such as bitcoin, Ripple and Litecoin,
“are essentially money in the form of artificial commodities of limited total supply, which are
transmittable quickly and without cost over the internet without a financial intermediary”).
115
. CFTC Order, Coinflip Enforcement, supra note 115, at 2 n.2; see also FINCEN,
GUIDANCE ON REGULATION OF VIRTUAL CURRENCY, supra note 115 (quoting 31 C.F.R. §
1010.100(m), which defines “real currency” as “the coin and paper money of the United States
or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is
customarily used and accepted as a medium of exchange in the country of issuance”).
116
. Id. at 2.
117
. Grinberg, supra note 23, at 175.
118
. See Mary Thompson, Investing in Digital Currencies: Risks and Rewards, CNBC
(June 20, 2014), http://www.cnbc.com/2014/06/18/investing-in-digital-currencies-risks-and-
rewards.html (discussing the changing landscape of digital currency and the risks as well as
potential benefits for investors); Emily Spaven, MasterCard: Digital Currency’s Risks Out-
weigh the Benefits, COINDESK (June 8, 2015), http://www.coindesk.com/mastercard-digital-
currencys-risks-outweigh-the-benefits/ (reporting that MasterCard submitted comments in re-
sponse to the UK Treasury’s call for information on digital currency in which the payment
processor argued that there is a lack of consumer protection in the digital currency space).
119
. Why Use Bitcoin?, COINDESK, http://www.coindesk.com/information/why-use-
bitcoin/ (last updated Feb. 20, 2014). The inflation protection arises due to the finite number
of bitcoins that can be created. Notwithstanding, the value of a bitcoin can fluctuate wildly
based upon demand, as with any other commodity.
2016] NEW WINE INTO OLD BOTTLES 41
ians and technologists with little experience in the financial services in-
dustry—claimed it was unregulated.
120
However, as consumers have
been harmed through malfeasance and negligence (for example, Mt. Gox,
at one time the largest bitcoin exchange, failed and lost approximately
$500 million worth of customer bitcoins),
121
regulators have been clari-
fying how existing regulations apply to this new technology, and busi-
nesses have been running into the buzz saw of existing regulatory
schemes.
122
In no particular order, this article highlights the most im-
portant issues relating to digital currency and its use as money. The dis-
tributed ledger technology (often referred to as “blockchain”) powering
bitcoin and other digital currencies raises other interesting regulatory is-
sues that are beyond the scope of this article.
1. Regulation of the Business of Transmitting Money
Traditionally, money transmission laws might have made one
think of the Western Unions or MoneyGrams of the world, which receive
funds for the purpose of remitting those funds to third parties, either in-
side or outside the United States,
123
but advances in technology have per-
mitted the introduction of a myriad of new players in the money trans-
mission space.
124
For example, if after dining out with a friend, my friend
and I decide to split the bill, I may cover the entire bill then send a request
to my friend for his portion of the bill using the smartphone application
Venmo.
125
Digital currencies can provide a method of transferring funds
from one person to another that is much less expensive than other meth-
ods. However,just because an entity avoids the “bank” definition does
not mean that the entity escapes regulation.
120
. See Thompson, supra note 118.
121
. Tom Hals, Failed Bitcoin Exchange Mt. Gox Gets U.S. Bankruptcy Protection,
REUTERS, Jun. 17, 2014, http://www.reuters.com/article/2014/06/17/us-bitcoin-mtgox-bank-
ruptcy-idUSKBN0ES2WZ20140617#R6ATUFibO3bgQe3B.97.
122
. See generally Grinberg, supra note 114; DAVIS POLK VISUAL MEMORANDUM, NEW
YORK’S FINAL “BITLICENSE” RULE: OVERVIEW AND CHANGES FROM 2014 PROPOSAL (June 5,
2015), http://www.davispolk.com/sites/default/files/2015-06-05_New_Yorks_Final_Bit-
License_Rule.pdf.
123
. SIVON, supra note 92, 54, 86.
124
. See id. at 16, 87–88; KEVIN TAYLOR, supra note 94, § 5.III.
125
. Venmo is a digital wallet, which allows users to pay and request money from other
users with whom they connect. About, VENMO, https://help.venmo.com/customer/en/portal/
articles/1322558-what-is-venmo- (last visited nov. 19, 2015). See also TAYLOR, supra note
94, § 5.II.B.
42 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
A. FEDERAL REGULATION OF MONEY TRANSMISSION
On March 18, 2013, the U.S. Department of the Treasury Finan-
cial Crimes Enforcement Network (“FinCEN”) issued administrative
guidance declaring that a virtual currency would not be deemed a “cur-
rency” under regulations implementing the BSA, but that certain virtual
currency businesses would nevertheless be money transmitters under the
BSA, subject to regulation as money services businesses (“MSB”).
126
The FinCEN guidance described three types of actors: (i) users,
who obtain virtual currency to purchase goods or services; (ii) exchang-
ers, who engage in the business of exchanging virtual currency for real
currency, funds or other virtual currency; and (iii) administrators, who
engage in the business of issuing virtual currency and have the authority
to redeem such virtual currency.
127
While “users” would not be deemed
to be “money transmitters,” “exchangers” and “administrators” would be
deemed “money transmitters” under the BSA and would be subject to
various registration, reporting and recordkeeping requirements as
MSBs.
128
On January 30, 2014 and October 27, 2014, FinCEN issued a se-
ries of administrative rulings clarifying the scope of its guidance.
129
These rulings confirmed that a “miner”
130
of virtual currency would not
be an MSB as long as the virtual currency was used for the miner’s own
purposes, and not for the benefit of another person,
131
and that investing
126
. FINCEN, GUIDANCE ON REGULATION OF VIRTUAL CURRENCY, supra note 115.
127
. Id.
128
. Id. This includes the filing of suspicious activity reports (“SARs”), currency trans-
action reports (“CTRs”), and putting in place know-your-client (“KYC”) and anti-money
laundering (“AML”) compliance programs. See Rules for Money Services Businesses, 31
C.F.R. § 1022.210 (2011).
129
. See DEP’T OF TREASURY FINANCIAL CRIMES ENFORCEMENT NETWORK, FIN-2014-
R001, GUIDANCE: APPLICATION OF FINCEN’S REGULATIONS TO VIRTUAL CURRENCY MINING
OPERATIONS (Jan. 30, 2014) [hereinafter FINCEN, GUIDANCE ON VIRTUAL CURRENCY MINING
OPERATIONS] (providing guidance on the application of FinCEN’s regulations to virtual cur-
rency mining operations); DEP’T OF TREASURY FINANCIAL CRIMES ENFORCEMENT NETWORK,
FIN-2014-R012, GUIDANCE: REQUEST FOR ADMINISTRATIVE RULING ON THE APPLICATION OF
FINCEN’S REGULATIONS TO A VIRTUAL CURRENCY PAYMENT SYSTEM, (Oct. 27, 2014) [here-
inafter FINCEN, GUIDANCE ON VIRTUAL CURRENCY PAYMENT SYSTEMS] (providing guidance
on the application of FinCEN’s regulations to a virtual currency payment system).
130
. One “mines” for bitcoins by compiling recent transactions into blocks and trying to
solve a computationally difficult problem. The reward for this activity is paid in bitcoins.
131
. FINCEN, GUIDANCE ON REGULATION OF VIRTUAL CURRENCY, supra note 115.
2016] NEW WINE INTO OLD BOTTLES 43
in virtual currencies for one’s own account would not be subject to regu-
lation as an MSB.
132
Conversely, a person operating a platform for the
exchange of virtual currencies to real currencies would be subject to reg-
ulation as an MSB,
133
as would a person operating a payment system that
allows merchants to receive payments in virtual currencies from their cus-
tomers.
134
Following its guidance and rulings, on May 5, 2015, FinCEN
fined Ripple Labs, a San Francisco-based start-up, $700,000 for failure
to register as an MSB.
135
Ripple Labs had developed its own open-source
code for a blockchain separate from the bitcoin blockchain, with its own
native currency known as “XRP.”
136
The settlement with Ripple stipu-
lated that Ripple had violated the BSA by selling XRP without registering
as an MSB or having anti-money laundering (“AML”) programs in
place.
137
B. STATE REGULATION OF MONEY TRANSMISSION
The act of transferring money or value from one person to another
also brings into play the state statutes licensing money transmitters.
138
The Georgia prohibition on engaging in the banking business discussed
above is again illustrative, for the prohibition includes “receiving money
for deposit or transmission,” unless one is properly licensed, registered
or qualifies for an exemption.
139
Virtually every state regulates money
transmitters,
140
and while requirements vary from state to state, they typ-
ically include some form of minimum net worth, maintenance of a bond,
132
. DEP’T OF TREASURY FINANCIAL CRIMES ENFORCEMENT NETWORK, FIN-2014-R002,
GUIDANCE: APPLICATION OF FINCEN’S REGULATIONS TO VIRTUAL CURRENCY SOFTWARE
DEVELOPMENT AND CERTAIN INVESTMENT ACTIVITY (Jan. 30, 2014).
133
. DEP’T OF TREASURY FINANCIAL CRIMES ENFORCEMENT NETWORK, FIN-2014-R011,
GUIDANCE: REQUEST FOR ADMINISTRATIVE RULING ON THE APPLICATION OF FINCEN’S
REGULATIONS TO A VIRTUAL CURRENCY TRADING PLATFORM (Oct. 27, 2014).
134
. FINCEN, GUIDANCE ON VIRTUAL CURRENCY PAYMENT SYSTEMS.
135
. Dep’t of Treasury Financial Crimes Enforcement Network Assessment of Civil
Money Penalty, In the Matter of Ripple Labs Inc., FinCEN Number 2015-05 (May 5, 2015).
136
. Id.
137
. Id.
138
. SIVON ET AL., supra note 92, 85. See also Tu, supra note 93, 86–8; Lawrence Tra-
utman, Virtual Currencies; Bitcoin & What Now After Liberty Reserve, Silk Road, and Mt.
Gox, 20 RICH. J.L. & TECH. 13 (2014).
139
. GA. CODE ANN. § 7-1-241 (West 2015).
140
. SIVON ET AL., supra note 92, 85. See also Tu, supra note 93, at 86–8.
44 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
annual audits, examinations by regulators, recordkeeping, AML pro-
grams, and a list of permissible investments for funds received and
held.
141
Through money transmission licenses, the state can protect the
funds of its citizens and help prevent money laundering.
142
These statutes are clearly triggered when a money transmitter
maintains an office or an agent in a state (the agent may also be a money
transmitter itself and may require a license), but a physical presence is
not necessary to invoke the statute and merely having an internet website
that does not block access to a resident in a state may be enough to im-
plicate a state’s licensing requirements.
143
Some states are silent on the
need for a physical presence, but take the position that receiving funds
from residents of the state is sufficient to invoke the statutory require-
ments.
144
Others are more explicit in their position that a physical pres-
ence is not required.
145
The state money transmitter statutes typically hinge on transmit-
ting “money” or “funds,” which are often broad enough to encompass
digital currencies.
146
For example, New York law covers “payment in-
struments,”
147
while Oklahoma law covers the transfer of “the value of
the currency or funds.”
148
States appear to be taking different approaches on the regulation
of digital currency, with some clarifying that the use of digital currencies
to transfer funds from one person to another is within the statute, while
141
. SIVON ET AL., supra note 92.
142
. MARIANNE CROWE ET AL., THE U.S. REGULATORY LANDSCAPE FOR MOBILE
PAYMENTS 1, 6–7, 9 (July 25, 2012), https://www.frbatlanta.org/rprf/publications.aspx. See
also SIVON, supra note 92.
143
. Trautman, supra note 138, at 23–6. Moreover, under some state money transmitter
laws, if a person in a state can access the website of a business that engages in money trans-
mission in another state, then that business would be considered to be a money transmitter in
the state in which the person is accessing the website. See, e.g., N.C. GEN. STAT. § 53-
208.3(c)(West 2015) (“[A] person is considered to be engaged in the business of money trans-
mission in this State if that person makes available, from a location inside or outside of this
State, an Internet website North Carolina citizens may access in order to enter into those trans-
actions by electronic means.”); W.VA. CODE ANN. § 32A-2-2 (a) (“For purposes of this article,
a person is considered to be engaging in those businesses in this state if he or she makes
available, from a location inside or outside this state, an internet website West Virginia citi-
zens may access in order to enter into those transactions by electronic means.”).
144
. Id. at 23–26.
145
. Id.
146
. Tu, supra note 93, 86–8.
147
. N.Y. BANKING LAW § 641.
148
. OKLA. STAT. tit. 6 §1512 (2013).
2016] NEW WINE INTO OLD BOTTLES 45
others seem to be taking the opposite position.
149
For example, in the
State of Washington, digital currency is captured by the definition of
“money transmission” in its Uniform Money Services Act.
150
However,
Texas has issued guidance in which it takes the position that virtual cur-
rency is not considered a currency or monetary value under the Texas
Money Services Act and therefore receiving virtual currency in exchange
for a promise to make it available at a later time or different location is
not a money transmission.
151
Kansas has taken the same position as
Texas, issuing guidance stating that decentralized digital currencies like
bitcoin are not covered by the Kansas Money Transmitter Act because by
definition cryptocurrencies are not considered “money” or “monetary
value” by the Office of the State Bank Commissioner.
152
Thus, an entity
engaged solely in the transmission of cryptocurrencies would not be re-
quired to obtain a money transmitting license in the State of Kansas.
153
States that allow registration under their money transmitting stat-
utes are seeing applications filed by entities that wish to transmit money
in digital currency form. One such example is Coinbase, a bitcoin wallet
and platform for transacting in bitcoin.
154
Coinbase currently holds li-
censes in twenty-six U.S. states and territories.
155
For a company that was founded with the expectation that it
would be required to comply with standard AML regimes, compliance
with the money transmitter laws of a state is not particularly difficult or
onerous. However, for some businesses that expect to be unregulated,
and for bitcoin businesses focused on the privacy and anonymity of their
customers (e.g., ShapeShift.io), it would be difficult or impossible to
149
. SIVON ET AL., supra note 92, 85–6, 90–1 (“Like federal financial regulators, state reg-
ulators have focused attention on the role of virtual currencies in payment and other financial
transactions. Not surprisingly, the state responses have not been uniform.”).
150
. WASH. STATE DEP’T OF FIN. INST. VIRTUAL CURRENCY REGULATION, http://
www.dfi.wa.gov/documents/money-transmitters/virtual-currency-regulation.pdf (last visited
Nov. 18, 2015).
151
. Tex. Dep’t of Banking, Supervisory Memorandum 1037, Regulatory Treatment of
Virtual Currencies Under the Texas Money Services Act 2–3 (Apr. 3, 2014), http://
www.dob.texas.gov/public/uploads/files/consumer-information/sm1037.pdf.
152
. Kan. Office of the State Bank Commissioner Guidance Document, MT 2014-01,
Regulatory Treatment of Virtual Currencies Under the Kansas Money Transmitter Act 2–3
(June 6, 2014), http://www.osbckansas.org/mt/guidance/mt2014_01_virtual_currency.pdf.
153
. Id.
154
. COINBASE, ABOUT, https://www.coinbase.com/about (last visited Nov. 18, 2015).
155
. COINBASE, LICENSES, https://www.coinbase.com/legal/licenses (last visited Nov. 18,
2015).
46 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
comply without significant changes to their technology, organizations or
business models. More importantly, even a business that wishes to com-
ply with all applicable regulatory requirements may well find that the cu-
mulative effect of dealing with multiple states—and potentially every
state—overwhelming.
156
There is a time and cost component to complying with the varied
and occasionally conflicting state laws. An entity attempting to operate
on a nationwide basis may find that obtaining necessary state licenses can
take one to two years or more. In addition, licensing and compliance may
cost millions of dollars in legal, consulting, and other fees, not to mention
the opportunity cost of having management’s focus diverted away from
building the business.
157
Many entities may strive to work around this
issue by attempting to limit or preclude customers from a particularly dif-
ficult or onerous jurisdiction.
158
Other institutions try to side-step these
issues by becoming an agent of an already registered money transmitter.
However, few if any of the licensed money transmitters have been inter-
ested in allowing the bitcoin businesses to become their agents. Given
the risks of the use of digital currencies in money laundering and other
criminal activities, the licensed money transmitters likely fear that the
activities of the bitcoin businesses will imperil their licenses and relation-
ships with regulators. Unfortunately, some digital currency companies
appear to prefer to operate until such time as a particular state might ob-
ject, believing that it will be acceptable to register and comply after the
fact. Experience highlights the risks of such a strategy. Besides being
subject to state and federal money transmission and money services busi-
ness regimes,
159
entities engaged in transmitting money likely must com-
ply with OFAC requirements,
160
consumer protection obligations, as well
156
. Trautman, supra note 138, at 23–6.
157
. It took Coinbase two years and $2 million to complete the application and receive
licenses to be a money transmitter laws in 26 states. Michael del Castillo, Fred Wilson: Op-
pressive Bitcoin Regulation Could Make Silicon Valley the ‘Next Wall Street’, N.Y. BUS. J.
(Apr. 24, 2015), http://www.bizjournals.com/newyork/news/2015/04/24/fred-wilson-silicon-
valley-next-wall-street.html; COINBASE, LICENSES, https://www.coinbase.com/legal/licenses
(last visited Nov. 24, 2015).
158
. Tu, supra note 93, 112 (“The costs of evaluating whether compliance is necessary,
the actual costs of becoming licensed and otherwise satisfying the regulatory requirements,
and the risks of operating without a license may all act as a deterrent to those who wish to
develop payment innovations.”).
159
. Bank Secrecy Act; 31 U.S.C. §§ 5311–5330 (2001); see also TAYLOR, supra note 94,
§ 5.II.B, § 5.III.D.1.
160
. SIVON, supra note 92,at 63; see infra notes 178–198 and accompanying text.
2016] NEW WINE INTO OLD BOTTLES 47
as the CFPB’s Remittance Rule.
161
C. BITLICENSES AND DIGITAL CURRENCY-SPECIFIC
STATE REGIMES
Because many of the money transmitter statutes neither squarely
cover digital currencies nor provide the degree of regulatory oversight
desired, the New York Department of Financial Services has established
a “BitLicense” regime.
162
The regime requires that those involved in
“Virtual Currency Business Activity” in or involving the state of New
York must apply for a license and adhere to the substantive requirements
of the regime.
163
The BitLicense regime can be described as “money
transmitter plus” because, in addition to imposing requirements similar
to those imposed by money transmitter regulation, the BitLicense regime
also imposes requirements tailored to the unique nature of the virtual cur-
rency business, such as cybersecurity and special suspicious activity re-
ports (“SARs”).
164
Virtual Currency Business Activity includes: (1) receiving virtual
currency for transmission or transmitting virtual currency; (2) storing,
holding or maintaining custody or control of virtual currency for others;
161
. Electronic Fund Transfers (Regulation E), 12 C.F.R. § 1005 (2012); TAYLOR, supra
note 94, § 5.II.B.
162
. N.Y. LAWS § 200.3. See also Speech, Superintendent Lawsky’s Remarks at the BITS
Emerging Payments Forum (June 3, 2015), http://www.dfs.ny.gov/about/speeches/
sp1506031.htm (“The first instinct among some at NYDFS was to shoehorn these new digital
currency firms into our old money transmission rules. However, state money transmission
rules date back to the civil war—when there was barely mass communication, let alone an
Internet. And it became increasingly clear to us that such an approach simply would not
work.”); Davis Polk Client Memorandum, New York’s Final “BitLicense” Rule: Overview
and Changes from 2014 Proposal (June 5, 2015), http://www.davispolk.com/sites/default/
files/2015-06-05_New_Yorks_Final_BitLicense_Rule.pdf (providing summary of changes
from and clarifications to the July 2014 proposal); SIVON ET AL., supra note 92, 85–86, 90–91
(2014) (“Like federal financial regulators, state regulators have focused attention on the role
of virtual currencies in payment and other financial transactions . . . The New York Depart-
ment of Financial Services (NYDFS) has been in the forefront of state efforts to regulate
virtual currencies.”).
163
. N.Y. LAWS § 200.3. See also SIVON ET AL., supra note 92, 85–86, 90–91 (2014)
(“Like federal financial regulators, state regulators have focused attention on the role of vir-
tual currencies in payment and other financial transactions. . . . The New York Department
of Financial Services (NYDFS) has been in the forefront of state efforts to regulate virtual
currencies.”); Speech, Superintendent Lawsky’s Remarks at the BITS Emerging Payments
Forum (June 3, 2015), http://www.dfs.ny.gov/about/speeches/sp1506031.htm.
164
. See Davis Polk Client Memorandum, New York’s Final “BitLicense” Rule, supra
note 162, at 5 (providing summary of requirements).
48 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
(3) buying or selling virtual currency as a customer business; (4) perform-
ing exchange services; and (5) controlling, administering or issuing a vir-
tual currency.
165
While certainly broad, the licensing regime would ex-
clude mere merchants and consumers, the development of software,
digital currency “miners,” and nonfinancial uses of digital currencies.
166
The regime imposes disclosure, recordkeeping, and fraud prevention ob-
ligations, books and records requirements, AML and know your customer
requirements, certain actions designed to safeguard assets and customer
funds, security obligations and the like.
167
The Conference of State Bank Supervisors has issued a model
framework that largely mirrors the New York framework.
168
The Uni-
form Law Commission is also in the process of drafting a statute that
“will create an appropriate licensing regime for virtual currency transac-
tions,”
169
and has released a draft of its proposed regulations.
170
While,
as of the date of this article, no state other than New York has adopted a
165
. N.Y. LAWS § 200.3; Superintendent Benjamin M. Lawsky, Remarks at the BITS
Emerging Payments Forum, supra note 163; Davis Polk, New York’s Final “BitLicense”
Rule, supra note 162, at 11.
166
. N.Y. LAWS § 200.3; Davis Polk, New York’s Final “BitLicense” Rule, supra note
162, at 11.
167
. N.Y. LAWS § 200.15–200.20. See also Davis Polk, New York’s Final “BitLicense”
Rule, supra note 162, at 29–48 (discussing safeguarding assets, cyber security programs, anti-
money laundering and exam, reports and oversight of BitLicense regime).
168
. CONFERENCE OF STATE BANK SUPERVISORS, STATE REGULATORY REQUIREMENTS FOR
VIRTUAL CURRENCY ACTIVITIES: CSBS MODULE REGULATORY FRAMEWORK (Sept. 15, 2015),
https://www.csbs.org/regulatory/ep/Documents/CSBS-Model-Regulatory-
Framework%28September%2015%202015%29.pdf.
169
. ULC UPDATES, UPDATE ON DRAFTING COMMITTEE ON REGULATION OF VIRTUAL
CURRENCIES (Oct. 16, 2015), https://uniformlaws.wordpress.com/2015/10/16/update-on-
drafting-committee-on-regulation-of-virtual-currencies/.
“Because the draft act is contemplated as a licensing regime, the format of the first draft fol-
lowed in many ways the format of the Uniform Money Services Act (promulgated by the
ULC in 2000), and also followed the draft framework recently put forth by CSBS (Conference
of State Bank Supervisors) as a starting point. The draft also borrowed definition language
from the U.S. Treasury Department’s Financial Crimes Enforcement Network (‘FinCEN’),
and, to a lesser extent, from the final ‘Bitlicense’ regulation that has been promulgated by the
New York State Department of Financial Services. The present draft includes licensing re-
quirements, reciprocity and use of licensing systems, requirements for financial strength and
stability, provisions aimed at cybersecurity, and provisions on the books and records, super-
vision and enforcement, compliance with other laws, and consumer (or more broadly ‘user’)
protections including disclosure, and substantive provisions such as a dispute resolution pro-
cedure.” Id.
170
. NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS, DRAFT
REGULATION OF VIRTUAL CURRENCIES ACT (2015), http://www.uniformlaws.org/shared/docs/
regulation%20of%20virtual%20currencies/2015oct_RVCA_Mtg%20Draft.pdf.
2016] NEW WINE INTO OLD BOTTLES 49
virtual currency-specific regime,
171
it is exciting to consider that a model
statute may pave the way for reciprocity, allowing an entity licensed un-
der one state statute to also do business in another state without applying
for a virtual currency-specific license in that state if both states’ statutes
are based on the model.
While reciprocity does not currently exist under the BitLicense
regime, at least one bitcoin firm that obtained a New York trust charter
(as opposed to a BitLicense) is claiming reciprocity in all fifty states.
172
On May 7, 2015, itBit, a bitcoin exchange, became the first virtual cur-
rency company to be chartered as a limited purpose trust in New York
permitted to engage in virtual currency activity.
173
On the day itBit re-
ceived its license, it announced it would open for business in all fifty
states, arguing that it had been organized under New York banking law,
which has reciprocity throughout the United States.
174
However, neither
New York nor any other state has confirmed that itBit will receive reci-
procity, although no state has begun enforcement actions against it.
175
Notably, the spokesman for the California Department of Business Over-
sight stated: “[w]e’re not prepared to agree that ItBit . . . can conduct
171
. Recently, California considered adopting a BitLicense regime—largely based on
New York’s—but the bill failed to pass in the legislature prior to the September 11, 2015
deadline. See generally California Bitcoin Bill Dies in the Legislature, Blockchain Agenda
(Sept. 16, 2015), http://insidebitcoins.com/news/california-bitcoin-bill-dies-in-the-legisla-
ture/34864; Bitcoin, the California Legislature, and the Future of Cryptocurrency Regulation,
DCE Brief (Oct. 13, 2015), http://dcebrief.com/bitcoin-the-california-legislature-and-the-fu-
ture-of-cryptocurrency-regulation/.
172
. Davis Polk, New York’s Final “BitLicense” Rule, supra note 162, at 3.
173
. Id.
174
. Id. Forty-five states have signed the CSBS’s Nationwide Cooperative Agreement for
Supervision and Examination of Multi-State Trust Institutions. CSBS, NATIONWIDE
COOPERATIVE AGREEMENT, https://www.csbs.org/regulatory/Cooperative-Agreements/
Pages/42signedStates.aspx (last visited Nov. 23, 2015). If a state is a signatory to this agree-
ment then it allows trust banks organized under those states’ laws to engage in trust activities
in the other states that have also signed the agreement. See CSBS, NATIONWIDE COOPERATIVE
AGREEMENT FOR SUPERVISION AND EXAMINATION OF MULTI-STATE TRUST INSTITUTIONS,
https://www.csbs.org/regulatory/Cooperative-Agreements/Documents/nation-
wide_agrmnt_multi-state_trust_op.pdf (last visited Nov. 23, 2015). Additionally, the NY
DFS issued Gemini, a bitcoin exchange founded by the Winklevoss twins, a trust license in
October 2015. Press Release, N.Y. Dep’t of Fin. Serv., NYDFS Grants Chart to “Gemini”
Bitcoin Exchange Founded by Cameron and Tyler Winklevoss (Oct. 5, 2015), http://
www.dfs.ny.gov/about/press/pr1510051.htm; see also Paul Vigna, Winklevoss Twin’s Gem-
ini Exchange Gets Trust License-Bitbeat, WALL ST. J. (Oct. 5, 2015), http://blogs.wsj.com/
moneybeat/2015/10/05/bitbeat-winklevoss-twins-gemini-exchange-gets-trust-license/ (dis-
cussing the grant of a charter under New York Banking Law to Gemini to operate as a virtual
currency exchange).
175
. Id.
50 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
exchange transactions with Californians under its New York certifi-
cate.”
176
It should be noted that institutions licensed to engage in virtual
currency activities through a New York trust charter, such as itBit, still
must comply with the substantive requirements of the BitLicense re-
gime.
177
2. OFAC
As is familiar to bankers, the U.S. government uses economic and
trade sanctions to advance its foreign policy and national security inter-
ests and objectives.
178
Sanctions may be imposed against countries or
geographic areas and all organizations, individuals and entities (“Per-
sons”) within those areas, or against designated Persons or governments,
wherever located.
179
OFAC is the primary federal agency administering
and enforcing U.S. economic sanction programs.
180
There are a number
of federal statutes currently in effect which authorize the executive
branch to restrict or otherwise regulate commercial and other contacts
between U.S. Persons
181
and sanctioned parties.
182
Each of these statutes
176
. Id.
177
. Id.
178
. U.S. DEP’T OF TREASURY, OFAC FAQS: GENERAL QUESTIONS, http://www.treas-
ury.gov/resource-center/faqs/Sanctions/Pages/faq_general.aspx (last visited Nov. 12, 2015)
(“[S]anctions can be either comprehensive or selective, using the blocking of assets and trade
restrictions to accomplish foreign policy and national security goals.”).
179
. Id.
180
. U.S. DEP’T OF TREASURY, ABOUT, http://www.treasury.gov/about/organizational-
structure/offices/Pages/Office-of-Foreign-Assets-Control.aspx (last visited Nov. 13, 2014).
In addition, OFAC and the U.S. State Department administer certain “secondary” sanctions
targeting non-U.S. Persons located in non-Target Countries that engage in certain activities
involving Iran or Russia. See Paul J. Sanders, Will U.S. Sanctions Disrupt Iran-Russia Eco-
nomic Ties?, US NEWS (Aug. 24, 2015), http://www.usnews.com/news/articles/2015/08/24/
will-us-sanctions-disrupt-iran-russia-economic-ties.
181
. “U.S. Persons” include: citizens of the United States, wherever located; permanent
resident aliens (i.e., “green card” holders), wherever located; all entities organized in the
United States (including their foreign branches); and all Persons actually located in the United
States. 31 C.F.R. § 560.314 (2015).
182
. These include the Trading with the Enemy Act, 50 U.S.C.§§ 1-44 (2012), the Inter-
national Emergency Economic Powers Act, 50 U.S.C. §§ 1701–1706 (2007) (“IEEPA”), the
United Nations Participation Act, 22 U.S.C. § 287c (2010) (which provides the executive
branch with the authority to implement mandatory provisions of United Nations Security
Council Resolutions), and a number of regulations which impose a variety of sanctions and
restrictions on contacts with specific countries, such as Cuba and Iran. See, e.g., 31 C.F.R. §
515 et seq. (2015) (providing sanctions and restrictions on contracts with Cuba); 31 C.F.R. §
561 et seq. (2015) (providing sanctions that relate to financial transactions with Iran).
2016] NEW WINE INTO OLD BOTTLES 51
has civil and criminal penalties and many of them overlap.
183
While U.S. economic sanctions compliance generally applies to
all U.S. Persons, the financial sector is subject to a higher level of scrutiny
by OFAC and an aggressive level of enforcement.
184
As technology com-
panies enter this space, they will invite the enhanced scrutiny leveled on
the banking and financial sectors. As noted, a variety of statutes authorize
the president and the executive branch to impose sanctions against a va-
riety of individuals, entities and nations.
185
These sanction programs are
ordered by the president by way of executive order as authorized by one
of the underlying statutes.
186
OFAC then issues regulations that interpret
and implement the terms of presidential executive orders.
187
Under regulations administered by OFAC, U.S. Persons are gen-
erally prohibited from engaging in transactions, directly or indirectly,
with those Persons and countries or territories targeted by U.S. sanctions
(“Target Countries”), unless the transactions are exempt or licensed by
OFAC.
188
U.S. Persons are also generally prohibited from “facilitating”
183
. See BENJAMIN WOOD, ET AL., OFAC ENFORCEMENT OF U.S. INTERNATIONAL
ECONOMIC SANCTIONS § 9:4 (May 2015) (discussing civil and criminal enforcement of
OFAC’s regulations).
184
. OFAC does not regulate banks, but requires banks to comply with the laws that it
administers. See U.S. DEP’T OF TREASURY, OFAC FAQS: SANCTIONS COMPLIANCE, http://
www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_compliance.aspx (last visited
Nov. 13, 2015). The Federal Financial Institutions Examination Council (“FFIEC”) provides
examination guidelines at banks. See FFIEC, BANK SECRECY ACT ANTI-MONEY LAUNDERING
EXAMINATION MANUAL: OFFICE OF FOREIGN ASSETS CONTROL, http://www.ffiec.gov/
bsa_aml_infobase/pages_manual/olm_037.htm (last visited Nov. 12, 2015). Additionally, the
United States government has brought many recent prosecutions against large banks for vio-
lations of trade sanctions. See, e.g., Roy C. Smith & Ingo Walter, Getting Serious About
Sanctions-Busting Banks, WALL ST. J. (June 26, 2014), http://www.wsj.com/articles/roy-
smith-and-ingo-walter-getting-serious-about-sanctions-busting-banks-1403823813 (discuss-
ing the recent prosecution of BNP Paribas for violating trade sanctions with Iran and Sudan);
Christopher M. Matthews, Deutsche Bank to Pay $258 Million in Fines for Violating U.S.
Sanctions, WALL ST. J. (Nov. 4, 2015), http://www.wsj.com/articles/deutsche-bank-to-pay-
258-million-in-fines-for-violating-u-s-sanctions-1446661556.
185
. WOOD ET AL., supra note 183, § 9:1 (discussing regulatory authority of the president
to order OFAC to promulgate and administer sanctions).
186
. See id.
187
. See id.
188
. U.S. DEP’T OF TREASURY, OFAC FAQS: GENERAL QUESTIONS, supra note 178. There
is a recent exception to the traditional practice pursuant to which sanctions broadly prohibit
all transactions with sanctioned parties. In 2014, OFAC designed and implemented a new
type of sanctions, called “sectoral sanctions,” in response to Russia’s military actions in
Ukraine. The sectoral sanctions, which to date have been imposed only in the Russia/Ukraine
context, prohibit only limited and very specific types of business dealings with sanctioned
parties, in contrast to sweeping prohibitions on all types of dealings. See U.S. DEP’T OF
TREASURY, OFAC FAQS: OTHER SANCTIONS PROGRAMS, http://www.treasury.gov/resource-
52 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
or assisting actions of non-U.S. Persons, which could not be directly per-
formed by U.S. Persons due to U.S. sanctions restrictions.
189
This prohi-
bition on facilitating or assisting applies to the U.S. Person, even though
the non-U.S. Person is otherwise outside the scope of the OFAC proscrip-
tions.
Currently, the Target Countries are the Crimea region of Ukraine,
Cuba, Iran, Sudan, Syria, and, for certain transactions, North Korea.
190
The governments of Cuba, Iran, Sudan, and Syria, including their politi-
cal subdivisions, agencies and instrumentalities, and entities they own or
control directly or indirectly, are blocked.
191
In most cases, Persons lo-
cated, organized or residing in a Target Country are also considered “Tar-
get Persons.”
192
These Target Countries and Target Persons are subject
to various trade embargoes that ban imports and/or exports of goods and
services (including financial services) and technology into the United
States, from the United States, or by U.S. Persons.
193
OFAC also administers “list-based” sanctions that are imposed
on Persons designated under various programs for certain activities, pri-
marily those involved in narcotics, terrorism, proliferation of weapons of
mass destruction, and piracy.
194
The names of Persons designated under
center/faqs/Sanctions/Pages/faq_other.aspx#ukraine (last visited Nov. 12, 2015); U.S. DEP’T
OF STATE, UKRAINE AND RUSSIA SANCTIONS, http://www.state.gov/e/eb/tfs/spi/ukrainerussia/
(last visited Nov. 12, 2015). The nature and scope of the sectoral sanctions are beyond the
scope of this article.
189
. See WOOD, supra note 183, § 9:2.1 (discussing the ban against facilitation by U.S.
Persons in the context of U.S. trade sanctions against Sudan).
190
. See Exec. Order No. 13685, 79 FR 77357 (Dec. 19, 2014) (executive order blocking
certain persons and prohibiting certain transactions with respect to the Crimea Region of
Ukraine); 31 CFR §§ 515, 560, 538, 542, 510 (2015).
191
. In the definition of the government of these countries, the sanction regimes include
the political subdivisions of the Target Countries’ governments. See, e.g., 31 C.F.R. §
515.337 (2015) (broadly defining the government of Cuba as including political subdivisions
of the Government of Cuba); 31 C.F.R. § 560.304 (2015) (defining Government of Iran as
including “any political subdivision, or instrumentality. . .person owned or controlled, directly
or indirectly” by the government of Iran); 31 C.F.R. § 538.305 (2015) (defining the Govern-
ment of Sudan as including political subdivisions, agencies, or instrumentalities of the Gov-
ernment of Sudan); 31 C.F.R. § 542.305 (2015) (defining the Government of Syria as includ-
ing political subdivisions, agencies, or instrumentalities of the government of Syria).
192
. See, e.g., 31 C.F.R. §§ 560.201-07, 304, 306 (2015).
193
. U.S. DEP’T OF TREASURY, SANCTIONS PROGRAMS AND COUNTRY INFORMATION, http:/
/www.treasury.gov/resource-center/sanctions/Programs/Pages/Programs.aspx (last visited
Nov. 13, 2015).
194
. See U.S. DEP’T OF TREASURY, RESOURCE CENTER, http://www.treasury.gov/resource-
center/sanctions/SDN-List/Pages/default.aspx (last visited Nov. 12, 2015) (providing a
2016] NEW WINE INTO OLD BOTTLES 53
OFAC’s list-based sanction programs are placed on OFAC’s List of Spe-
cially Designated Nationals and Blocked Persons (the “SDN List”).
195
Banks are familiar with the OFAC regime and all it entails.
196
Using a variety of technology tools, as well as human review where ap-
propriate, financial institutions are generally able to identify potentially
prohibited transactions and take steps to block them.
197
There have been,
however, some spectacular failures, such as the $8.9 billion settlement
with BNP Paribas for transactions with Iran, Sudan, Burma and Cuba.
198
As a gross generalization, start-up technology companies tend not to be
as familiar with sanction requirements. In addition, because the rules re-
garding engaging in transactions (directly or indirectly) and facilitating
transactions are so broad, and given the ease of access to internet-based
technologies, having systems to monitor and control access and usage are
paramount.
199
The adaptation of bitcoins to finance money laundering
and criminal activity serves as a stark warning to those involved in digital
searchable list that includes certain designated persons that are involved in narcotics, terror-
ism, proliferation of weapons of mass destruction and privacy).
195
. The SDN List is provided on the U.S. Department of Treasury’s webpage. See U.S.
DEP’T OF TREASURY, SPECIALLY DESIGNATED NATIONALS LIST (SDN), http://www.treas-
ury.gov/resource-center/sanctions/SDN-List/Pages/default.aspx (last visited Nov. 13, 2015).
196
. Banks are subject to OFAC regulation and may face civil and criminal sanctions for
non-compliance. U.S. DEP’T OF TREASURY, OFAC FAQS: SANCTIONS COMPLIANCE, http://
www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_compliance.aspx (last visited
Nov. 13, 2015).
197
. See generally AM. BANKERS ASSOC., “SPECIALLY DESIGNATED WHO?”: A PRIMER ON
OFAC COMPLIANCE (1996), http://www.treasury.gov/resource-center/sanctions/Documents/
abamag.pdf (providing an overview of the role of technology and humans in maintaining an
OFAC compliance program).
198
. Press Release, U.S. Department of the Treasury (June 30, 2014) https://www.treas-
ury.gov/press-center/press-releases/Pages/jl2447.aspx. BNP Paribas entered into a $963 mil-
lion settlement with OFAC due to allegations that the bank systematically concealed, re-
moved, omitted or obscured references to information about transactions that it had engaged
in that violated OFAC’s regulations. This was part of a combined $8.9 billion settlement with
various federal and state government agencies, including the Federal Reserve, the New York
Department of Financial Services, the US Attorney for the Southern District of New York and
the New York County District Attorney’s Office. For a number of years, BNP Paribas alleg-
edly processed thousands of transactions, which exceeded $8 billion, that involved U.S. fi-
nancial institutions and countries, entities and/or individuals that were prohibited by OFAC’s
regulations. BNP Paribas supposedly made efforts to hide the identity of the parties of these
transactions to conceal that these transactions were being made in contravention of OFAC’s
regulations. See also http://www.bnpparibas.com/en/news/press-release/bnp-paribas-an-
nounces-comprehensive-settlement-regarding-review-certain-usd-trans.
199
. See WOOD, supra note 183, § 9:4 (emphasizing the importance of OFAC compliance
and providing the processes that are required for OFAC of compliance).
54 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
currencies of the dangers of inadvertently tripping over the OFAC obli-
gations.
200
3. Tax Considerations
The Internal Revenue Service (“IRS”) announced in March 2014
that it would treat virtual currencies, such as bitcoins, as property rather
than currency under federal tax law.
201
The tax authorities of some states
have announced that they will also treat virtual currencies, such as
bitcoins, as property under their tax laws.
202
Thus, purchases and sales
of bitcoins, and payments made with bitcoins, can be taxable events.
203
This would include purchases of goods, exchanges of bitcoins for legal
tender, wages or other payments made to independent contractors or ser-
vice providers.
204
200
. See DEP’T OF TREASURY, NATIONAL MONEY LAUNDERING RISK ASSESSMENT 62–4
(2015) (providing an overview of the past use of bitcoin to facilitate criminal activity and the
risks that bitcoin can facilitate money laundering). There have been a number of high profile
criminal cases where it has been alleged that bitcoin has been used to launder money and
facilitate criminal activity. See, e.g., Bob Van Voris, Ross Ulbricht Convicted of Running
Silk Road as Dread Pirate Roberts, BLOOMBERG BUS. (Feb. 4, 2015), http://www.bloom-
berg.com/news/articles/2015-02-04/ross-ulbricht-convicted-of-running-silk-road-as-dread-
pirate (providing that Ross Ulbricht was sentenced to life imprisonment for running the Silk
Road, which allowed users to use bitcoins to, among other things, purchase drugs and solicit
contract killings); Stan Higgins, U.S. Prosecutors Unseal New Charges Against Bitcoin Ex-
change Operator, COINDESK (Nov. 10, 2015), http://www.coindesk.com/us-prosecutors-un-
seal-new-charges-against-bitcoin-exchange-operator/ (providing that the former operator of
Coin.mx was charged with unlawful operation of a money transmitter business and laundering
money).
201
. I.R.S. Virtual Currency Guidance: Virtual Currency Is Treated as Property for U.S.
Federal Tax Purposes, I.R.S. Notice 2014-36 (Mar. 25, 2014) [hereinafter I.R.S. Guidance on
Virtual Currency]; General Rules for Property Transactions Apply, I.R.S. Notice 2014-21
(Mar. 25, 2014), https://www.irs.gov/pub/irs-drop/n-14-21.pdf [hereinafter I.R.S. General
Rules for Virtual Currency].
202
. See, e.g., NEW YORK STATE DEPARTMENT OF TAXATION AND FINANCE, TAX
DEPARTMENT POLICY ON TRANSACTIONS USING CONVERTIBLE VIRTUAL CURRENCY (Dec. 5,
2014), https://www.tax.ny.gov/pdf/memos/multitax/m14_5c_7i_17s.pdf (providing that for
sale taxes purposes convertible virtual currency is intangible property); WASHINGTON STATE
DEPARTMENT OF REVENUE, ACCEPTING VIRTUAL CURRENCY AS PAYMENT FOR GOODS OR
SERVICES, http://dor.wa.gov/content/getaformorpublication/publicationbysubject/taxtopics/
virtualcurrency.aspx (last visited Dec. 1, 2015) (providing that tax will apply to virtual cur-
rency the same way it applies to the sales of tangible property, digital products, or services
provided in exchange for virtual currency).
203
. I.R.S. Guidance on Virtual Currency, supra note 202; I.R.S. General Rules for Virtual
Currency, supra note 202. Similarly, when a taxpayer successfully “mines” virtual currency,
the fair market value of the virtual currency as of the date of receipt will be included in the
taxpayer’s gross income. I.R.S. General Rules for Virtual Currency, supra note 202, at 4.
204
. I.R.S. Guidance on Virtual Currency, supra note 202; I.R.S. General Rules for Virtual
2016] NEW WINE INTO OLD BOTTLES 55
The implications of the treatment of digital currencies as property
for users of bitcoin are fascinating. For example, if Sally buys a cup of
coffee at Starbucks for $4.00, but pays for the coffee using a digital cur-
rency she acquired at a cost of $2.00, she has realized a $2.00 capital gain
on the transaction.
205
Even more interesting is that there could not only
be a sales tax imposed on Starbucks for the sale of the coffee, Sally could
perhaps be deemed to have sold her digital currency for the $4.00 cup of
coffee and owe sales tax on her sale as well. The recordkeeping and com-
pliance costs seem overwhelming (and as a result, are perhaps most often
ignored),
206
but this seems to be the logical outgrowth of the IRS position.
4. Securities Laws Issues
While bitcoins themselves are not securities,
207
investment vehi-
cles that hold bitcoins and offer interests in the vehicles are securities.
208
Because of the novel nature of bitcoins and other digital currencies, the
SEC has indicated a high interest in investigating fraud and Ponzi
schemes involving bitcoins and has even issued an investor warning on
the risks of virtual currency-related investments.
209
For example, shares
of the Bitcoin Investment Trust were the first publicly quoted securities
representing an investment in bitcoin.
210
Additionally, in July 2013, the
Currency, supra note 202.
205
. I.R.S. General Rules for Virtual Currency, supra note 202, at 3 (“If the fair market
value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted
basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair
market value of the property received is less than the adjusted basis of the virtual currency.”).
206
. I.R.S. General Rules for Virtual Currency, supra note 202, at 5. According to I.R.S.
General Rules for Virtual Currency, the threshold for reporting requirements is for payments
using virtual currency with a value of $600 or more. Id. Some fintech start-ups are aimed at
assisting customers address their compliance obligations such as Libra, which advertises itself
as the “premiere accounting, reporting and tax compliance layer for blockchain technologies.”
LIBRA, http://libratax.com/ (last visited Nov. 18, 2015).
207
. See Letter from Mary Jo White, Chair, SEC, to Sen. Thomas R. Carper, Chairman,
Committee on Homeland Security and Governmental Affairs (Aug. 30, 2013), at 1 (stating
the SEC’s position that “[w]hether a virtual currency is a security under the federal securities
laws, and therefore subject to our regulation, is dependent on the particular facts and circum-
stances at issue.”); see also Grinberg, supra note 23, 195.
208
. See, e.g., Winklevoss Bitcoin Trust, Registration Statement, No. 333-189752 (Form
S-1) (July 1, 2013) (registration statement filing for Winklevoss Bitcoin Trust).
209
. SEC Investor Alert, Ponzi Schemes Using Virtual Currencies, SEC Pub. No. 153
(July 1, 2013) [hereinafter SEC Investor Alert, No. 153].
210
. GRAYSCALE, OVERVIEW, http://grayscale.co/bitcoin-investment-trust/ (last visited
Nov. 18, 2015). Shares of Bitcoin Investment Trust is traded under the symbol “GBTC” on
56 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
Winklevoss Bitcoin Trust filed its S-1 registration statement with the SEC
in order to sell shares of its bitcoin exchange-traded fund on NASDAQ
under the symbol “COIN.”
211
The S-1 has been amended five times, but
the SEC has not yet qualified the prospectus, meaning that no shares in
COIN have been publically sold.
Indeed, the SEC has brought a series of enforcement actions re-
garding bitcoin-related schemes.
212
The first involved a Ponzi scheme,
in which the judge levied a fine of more than $40 million, for violations
of Sections 5 and 17(a) of the Securities Act and Section 10(b) of the
Exchange Act.
213
The second action resulted in sanctions for operating
digital currency exchanges without registering as a broker-dealer or stock
exchange.
214
The third action involved a fine and prohibitions from any
bitcoin-related securities offerings, as a result of offering unregistered se-
curities in bitcoin ventures.
215
The fourth—but certainly not last—action
involved a bitcoin mining company purporting to offer shares of a digital
mining operation to investors but did not have the computer power nec-
essary to conduct the mining activity.
216
Thus while digital currencies
OTCQX. Id.
211
. Winklevoss Bitcoin Trust, Registration Statement, supra note 208. See e.g., Win-
klevoss Bitcoin Trust, Amendment No. 1 to Registration Statement, No. 333-189752 (Form
S-1/A) (Oct. 8, 2013) (amendment to registration statement filing for Winklevoss Bitcoin
Trust); Winklevoss Bitcoin Trust, Amendment No. 2 to Registration Statement, No. 333-
189752 (Form S-1/A) (Feb. 19, 2014) (amendment to registration statement filing for Win-
klevoss Bitcoin Trust); Winklevoss Bitcoin Trust, Amendment No. 3 to Registration State-
ment, No. 333-189752 (Form S-1/A) (May 8, 2014) (amendment to registration statement
filing for Winklevoss Bitcoin Trust).
212
. See SEC v. Trendon T. Shavers and Bitcoin Savings and Trust, SEC Litigation Re-
lease No. 23090 (Sept. 22, 2014), https://www.sec.gov/litigation/litreleases/2014/
lr23090.htm; BTC Trading, Corp., Exchange Act Release No. 73783 (Dec. 8, 2014); Erik
Voorhees, Securities Act Release No. 9592 (June 3, 2014).
213
. SEC v. Trendon T. Shavers, SEC Litigation Release No. 23090. In SEC v. Shavers,
an individual, Trendon Shavers, was found liable for defrauding investors out of more than
700,000 bitcoins by soliciting investments and offering returns to be paid out in bitcoin. Id.
Mr. Shavers promised up to 7% returns weekly based on his trading bitcoin against the U.S.
dollar, when in reality he used the new bitcoins to pay purported returns and to divert funds
for his own personal use. Id.
214
. BTC Trading, Exchange Act Release No. 73783. The SEC sanctioned an individual
and his alter ego foreign corporation, an unregistered entity through which he operated un-
registered, online, virtual currency-denominated securities exchanges and unregistered bro-
ker-dealers. Id.
215
. Erik Voorhees, Securities Act Release No. 9592. In Voorhees, the SEC issued a
cease-and-desist order against an individual for conducting unregistered offerings of bitcoin
through a bitcoin stock exchange. Id.
216
. Complaint, SEC v. Homero Joshua Garza, No. 3:15-cv-01760 (D. Conn. Dec 1,
2015).
2016] NEW WINE INTO OLD BOTTLES 57
may not in and of themselves be securities, as companies and individuals
seek methods to profit from their popularity, they may run afoul well-
established prohibitions under the various securities laws.
4. Commodities Laws
The Commodity Futures Trading Commission (“CFTC”) has ju-
risdiction over futures involving commodities,
217
and considers bitcoin
and other digital currencies to be included in the definition of commod-
ity.
218
In addition, other derivatives, such as swaps, hedges, options, trad-
ing platforms and exchanges involving commodities fall squarely within
the jurisdiction of the CFTC.
219
The CFTC has granted temporary regis-
trations as swap execution facilities to TeraExchange, LLC
220
and Ledg-
erX,
221
and is considering an application to launch a bitcoin binary op-
tions offering.
222
The CFTC recently settled its first enforcement action
involving an unregistered bitcoin derivatives trading platform.
223
217
. Under Section 1a(9) of the Commodity Exchange Act, the definition of “commodity”
includes, among other things, “all services, rights, and interests in which contracts for future
delivery are presently or in the future dealt in.” 7 U.S.C. § 1a(9) (2012).
218
. CFTC Order, Coinflip Enforcement, supra note 115, at 3 (“Bitcoin and other virtual
currencies are encompassed in the definition and properly defined as commodities.”).
219
. Id.
220
. CFTC Letter, Notice of Grant of Temporary Registration of TeraExchange, LLC as
a Swap Execution Facility Pursuant to Part 37 of the Commission’s Regulations (Sept. 19,
2013), http://www.cftc.gov/stellent/groups/public/@otherif/documents/ifdocs/teraexchange-
ltr091913.pdf.
221
. CFTC Letter No. 15-49, Notice of Grant of Temporary Registration of LedgerX LLC
as a Swap Execution Facility Pursuant to Part 37 of the Commission’s Regulations (Sept. 8,
2015), http://cftc.gov/groups/public/@otherif/documents/ifdocs/lgxsefregltr_151008.pdf.
222
. Diana Ngo, Derivatives Exchange Nadex Awaiting for CFTC Approval to Launch
Bitcoin Binary Options, COINTELEGRAPH.COM (Nov. 25, 2014), http://cointelegraph.com/
news/112987/derivatives-exchange-nadex-awaiting-for-cftc-approval-to-launch-bitcoin-bi-
nary-options. “The Bitcoin binary-option contracts will allow the trading of price movements
of the cryptocurrency, without the need to hold any Bitcoins.” Id.
223
. CFTC Order, Coinflip Enforcement, supra note 115 (“During the Relevant Period,
Coinflip operated a facility for the trading of swaps. However, Coinflip did not register the
facility as a swap execution facility or designated contract market. Accordingly, Coinflip
violated Section 5h(a)(l) of the Act and Regulation 37.3(a)(1).”). CFTC Order, TeraExchange
LLC, CFTC Docket No-15-33 (Sept. 24, 2015) [hereinafter CFTC Order, TeraExchange En-
forcement]. See also Davis Polk Client Memorandum, CFTC Brings First Bitcoin Enforce-
ment Action, Further Clarifying U.S. Regulatory Landscape for Virtual Currencies (Sept. 28,
2015), http://www.davispolk.com/sites/default/files/2015_09_28_CFTC_Brings_First_Bit-
coin_Enforcement_Action.pdf (providing analysis of CFTC order finding that Coinflip and
its founder violated provisions of the CEA and CFTC regulations governing transactions in
58 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
The order in the settled action confirms the CFTC’s regulatory
treatment of bitcoin (and other “virtual currencies”) as “commodities”
under the Commodities Exchange Act (“CEA”).
224
Based on this char-
acterization, the order applies CEA provisions and CFTC regulations
dealing with options and swaps to the trading platform in connection with
offering trading of bitcoin options.
225
As is made clear by the order, a
wide variety of activities involving virtual currency derivatives, which
could include futures, swaps or options referencing virtual currencies,
could cause a firm to be subject to registration and regulation by the
CFTC and its self-regulatory organization, the National Futures Associa-
tion (“NFA”).
226
In addition to trading platforms that may need to regis-
ter as swap execution facilities or designated contract markets,
227
firms
that provide referral or advisory services with respect to virtual currency
derivatives or that operate pooled investment vehicles that trade these de-
rivatives may need to register with the CFTC and the NFA.
In short, any business involved in virtual currency derivatives—
including foreign businesses that solicit or provide services to U.S. cus-
tomers—must consider whether its activities require it to register with the
CFTC.
228
The process of registering with the CFTC can be time-consum-
ing and costly, often taking a year or more for registration and costing a
commodity options, including provisions requiring trading platforms that offer swaps to reg-
ister with the CFTC).
224
. CFTC Order, Coinflip Enforcement, supra note 115 (“Bitcoin and other virtual cur-
rencies are encompassed in the definition and properly defined as commodities.”).
225
. Id. (“The definition of a ‘commodity’ is broad . . . Bitcoin and other virtual currencies
are encompassed in the definition and properly defined as commodities.”).
226
. Id.; see also Testimony of Chairman Timothy Massad before the U.S. Senate Com-
mittee on Agriculture, Nutrition and Forestry (Dec. 10, 2014), http://www.cftc.gov/Press-
Room/SpeechesTestimony/opamassad-6 (“Derivative contracts based on a virtual currency
represent one area within our responsibility . . . Innovation is a vital part of our markets, and
it is something that our regulatory framework is designed to encourage. At the same time, our
regulatory framework is intended to prevent manipulation and fraud, and to make sure our
markets operate with transparency and integrity.”).
227
. CFTC Order, TeraExchange Enforcement, supra note 224, citing 17 C.P.R. §
37.3(a)(l) (2014) (“Regulation 37.3(a)(1) similarly requires that any ‘person operating a fa-
cility that offers a trading system or platform in which more than one market participant has
the ability to execute or trade swaps with more than one other market participant on the system
or platform shall register the facility as a swap execution facility under this part or as a desig-
nated contract market under part 38 of this chapter.’”).
228
. See Testimony of Chairman Timothy Massad before the U.S. Senate Committee on
Agriculture, Nutrition and Forestry (Dec. 10, 2014), http://www.cftc.gov/PressRoom/Speech-
esTestimony/opamassad-6 (“Derivative contracts based on a virtual currency represent one
area within our responsibility. Recently, for example, a SEF registered with us made such a
2016] NEW WINE INTO OLD BOTTLES 59
significant amount of money, sometimes a million dollars or more, to
create the necessary infrastructure to ensure compliance with applicable
regulatory requirements and to complete the intensive application pro-
cess.
229
Firms whose virtual currency derivatives activities trigger CFTC
registration requirements should take into consideration the time and re-
sources necessary to complete the registration process before offering
those services.
D. Regulation of Entities Providing Services to Banks
Banks commonly outsource critical functions to third parties.
230
The regulators have adopted the common view that the financial institu-
tion is responsible for identifying and controlling any risks arising from
the third-party relationship, to the same extent that the institution would
if it were to conduct the function itself.
231
Interestingly, although not
clearly authorized by statute, the agencies view the Bank Service Corpo-
ration Act as giving them the authority to examine third parties that are
providing functions for the internal operations of the bank.
232
Indeed,
because the agencies take the view that the bank is simply delegating to
a third party activities that the bank itself could (and often should) con-
duct, the agencies have the same authority to examine the third party as
contract available. Innovation is a vital part of our markets, and it is something that our reg-
ulatory framework is designed to encourage. At the same time, our regulatory framework is
intended to prevent manipulation and fraud, and to make sure our markets operate with trans-
parency and integrity. Our responsibilities at the CFTC in this regard are ongoing.”).
229
. See NATIONAL FUTURES ASSOCIATION, WHO HAS TO REGISTER, https://www.nfa.fu-
tures.org/nfa-registration/index.HTML (last visited Nov. 18, 2105) (providing information on
who must register and how to register with the CFTC).
230
. Taylor, supra note 94, § 8.I (“Banks and other financial services companies fre-
quently outsource services required in their businesses.”).
231
. Taylor, supra note 94, § 8.IV (citing U.S. OFFICE OF THE COMPTROLLER OF THE
CURRENCY, OCC 2013-29, RISK MANAGEMENT GUIDANCE 1 (Oct. 30, 2013)).
232
. FED. FIN. INST. EXAMINATION COUNCIL, SUPERVISION OF TECHNOLOGY SERVICE
PROVIDERS 1 (Oct. 2012) (citing 12 U.S.C. §§ 1464(d)(7), 1867(c)). See also OCC, Bulletin
2013-29 (Oct. 30, 2013), http://www.occ.treas.gov/news-issuances/bulletins/2013/bulletin-
2013-29.html#; FDIC, GUIDANCE FOR MANAGING THIRD-PARTY RISK, http://www.fdic.gov/
news/news/financial/2008/fil08044a.pdf; BOARD OF GOVERNORS OF THE FED. RESERVE SYS.,
GUIDANCE ON MANAGING OUTSOURCING RISK (Dec. 5, 2013), http://www.federalreserve.gov/
bankinforeg/srletters/sr1319a1.pdf; CFPB Bulletin 2012-03 (Apr. 13, 2012), http://files.con-
sumerfinance.gov/f/201204_cfpb_bulletin_service-providers.pdf.
60 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
it has to examine the bank itself.
233
The agencies view the bank’s man-
agement and supervision of these relationships as part of its normal su-
pervisory process, and expect the bank to engage in necessary monitoring
and review of the activities.
234
Bank regulators have provided extensive guidance to banks re-
garding the management of their third-party vendor relationships.
235
This
guidance places significant responsibilities on the banks and highlights
the risks they must consider and evaluate, both as they enter into such
relationships and as they monitor existing relationships.
236
Vendors
should be prepared for this heightened regulatory interest, as it will be
reflected in ongoing dealings with the banks.
237
Accordingly, an entity providing a function or a service to a bank
may find regulators knocking on its doors to review policies, procedures,
controls, security, internal models, testing results, licenses and the like.
238
For instance, a company providing enhanced verification of customer
identities to assist in fraud detection and prevention may find the regula-
tors wanting to look at underlying algorithms or test results for inadvert-
ent bias having potentially disproportionate impacts on protected groups.
Because banks are attractive targets as customers for many
fintech companies, these companies need to be aware that they may be-
come subject to bank-like examination and supervision simply by provid-
ing services to the banks.
III. THE RISKS OF RISKING IT
Until recently, it has been the technology sector, rather than the
banking industry, that has been the driving force behind the current wave
of fintech start-ups. Technologists have led this drive by focusing on
ways that technology can enhance the everyday world. The technologists
leading the fintech explosion are of the same ilk as those that founded the
shared-economy companies Uber and Airbnb. As with those who
founded Uber and Airbnb, many of these technologists engaging in the
233
. See id.
234
. Taylor, supra note 94, § 8.IV.B (2014).
235
. Id.
236
. Id.
237
. Id.
238
. Id.
2016] NEW WINE INTO OLD BOTTLES 61
fintech industry are risk takers, often having a precarious relationship
with regulations and regulators and fitting into three broad categories.
239
The first category includes those that do not have a financial services
background and are genuinely unaware of the regulations to which they
may be subject. A second category recognizes that regulations exist but
make a pragmatic business decision to ignore the applicable regulations
prior to launching their new business to avoid regulatory scrutiny at the
start. A third category is composed of technologists who intend to violate
the law and have no regard for regulators, such as the case with the Silk
Road founder.
240
Those who fall within the first two categories, whether
intentionally or not, will seek to have their new technology in place and
thriving before regulators have even considered how it fits into the exist-
ing regulatory regimes.
241
This creates a difficult scenario for regulators,
as many of these products will provide substantial advantages to consum-
ers. They will have become accustomed to the advantages of the service
and regulatory intervention may frustrate those benefits.
242
For those de-
veloping technology to thwart the law, as discussed below, regulators are
acting swiftly and aggressively to combat illegal activity in the fintech
239
. In some cases, tech start-ups took the approach of “act now and ask for forgiveness
later.” For example, in the case of Uber, the ride-sharing service, the company is currently
facing regulatory backlash throughout the United States and abroad. From its inception, Uber
has aggressively moved into different markets with complete disregard for regulation. Only
afterwards have those countries, states, and local governments considered how to regulate the
service and/or challenged the service. For example, within days of Uber launching in Port-
land, Oregon, the city issued a cease-and-desist letter notifying the company that it was oper-
ating in violation of city law. Malia Spencer, City Sends Uber Cease-And-Desist Order, Uber
Fires Up a Petition, PORTLAND BUS. J. (Dec. 8, 2014), http://www.bizjournals.com/portland/
blog/techflash/2014/12/city-sends-uber-cease-and-desist-order-uber-fires.html.
240
. During his sentencing hearing, Ross Ulbricht, the founder of Silk Road, stated that
he created Silk Road to provide people with privacy and anonymity, thus empowering them.
Though not stated, this clearly indicates that Mr. Ulbricht intended to create a universe that
avoided the law and applicable regulations. Laurie Segall, Silk Road’s Ross Ulbricht Sen-
tenced to Life, CNN (May 29, 2015), http://money.cnn.com/2015/05/29/technology/silk-
road-ross-ulbricht-prison-sentence/index.html.
241
. See Andrew Vila & Kevin Gardner, Bringing Out the Regulatory Wheel Clamps for
Uber, WALL ST. J. (Sep. 27, 2015), http://www.wsj.com/articles/bringing-out-the-regulatory-
wheel-clamps-for-uber-1443385825 (noting that various states are attempting to regulate
ride-sharing services); see also, Tom Groenfeldt, New York State Aims for Sustainable Regu-
lation of Virtual Currencies, FORBES (Nov. 3, 2014), http://www.forbes.com/sites/tomgroen-
feldt/2014/11/03/new-york-state-aims-for-sustainable-regulation-of-virtual-currencies/ (not-
ing in connection with New York’s proposed BitLicense that “[v]irtual currencies are on [New
York’s] radar screen because we regulate money transmitters like Western Union and
Moneygram, but our rules were written long before the Internet or virtual currencies”).
242
. Vila & Gardner, supra note 241.
62 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
world.
As fintech expands and becomes more mainstream, regulation
can no longer be avoided by those developing fintech companies and de-
velopment of compliance infrastructures must be part of the business
plan.
243
As compliance programs are developed, fintech start-ups must
consider their relationships with their regulators or potential regulators,
including the possible long-term effects of avoiding interactions.
244
Not
complying with established laws and regulations can lead to criminal ac-
tions against the violator, regardless of whether the reason for non-com-
pliance was a lack of awareness or something more nefarious.
For example, in the virtual currency context, authorities are very
concerned about money laundering and have brought criminal charges
against those administrating and engaging in transactions related to Silk
Road and Silk Road 2.0, the online black marketplaces used to facilitate
criminal activity that have since been shut down by joint government task
forces.
245
Charlie Shrem, the former CEO of BitInstant, was arrested and
later sentenced to a two-year prison sentence for allegedly aiding in fa-
cilitating criminal activity relating to Silk Road.
246
Mr. Shrem started BitInstant as a senior at Brooklyn College,
made millions, and attracted the attention of wealthy investors.
247
How-
ever, it was later discovered that many of BitInstant’s customers were
using false identities,
248
and BitInstant had not been submitting SARs to
regulators even after flagging transactions for fraudulent activity.
249
In
some cases, BitInstant was used to unlawfully convert dollars into bitcoin
243
. See ARNER, supra note 13, at 18–21.
244
. Id.
245
. See generally Kim Zetter, How the Feds Took Down the Silk Road Drug Wonderland,
WIRED (Nov. 18, 2013), http://www.wired.com/2013/11/silk-road/; Andy Greenberg, Feds
Seize Silk Road 2 in Major Dark Web Drug Bust, WIRED (Nov. 6, 2014), http://
www.wired.com/2014/11/feds-seize-silk-road-2/.
246
. Nathaniel Popper, Charlie Shrem and the Ups and Downs of BitInstant, COINDESK
(May 19, 2015), http://www.coindesk.com/charlie-shrem-and-the-ups-and-downs-of-bitin-
stant/.
247
. See Max Raskin, Meet the Bitcoin Millionaires, BLOOMBERG BUS. (Apr. 10, 2013,
http://www.bloomberg.com/bw/articles/2013-04-10/meet-the-bitcoin-millionaires; Popper,
supra note 247.
248
. Popper, supra note 247.
249
. Kim Zetter, Bitcoin Exchange CEO Charged with Laundering $1Million through the
Silk Road, WIRED (Jan. 27, 2014), http://www.wired.com/2014/01/bitcoin-exchangers-ar-
rested/.
2016] NEW WINE INTO OLD BOTTLES 63
to fulfill orders for users of Silk Road.
250
After being arrested and
charged with conspiracy to commit money laundering and unlicensed
money transmission,
251
Mr. Shrem pleaded guilty to operating an unli-
censed money transmitting business, money laundering, and willful fail-
ure to file SARs with FinCEN
252
and received a two-year prison sen-
tence.
253
Another recent example of criminal charges being brought
against a member of the fintech community is the prosecution of Mark
Karpeles, the former head of Mt. Gox, the now-defunct bitcoin ex-
change.
254
On August 1, 2015, Mr. Karpeles was arrested in Japan in
connection with the 2014 disappearance of approximately $500 million
bitcoin following Mt. Gox’s bankruptcy filing in February 2014.
255
At
that time, Mt. Gox reported that 850,000 bitcoins were stolen due to a
software security flaw, but Mr. Karpeles was ultimately charged with em-
bezzling the bitcoins.
256
It was later discovered that Mt. Gox had amateur
and inadequate security systems and infrastructure, designed by Kar-
peles.
257
Those involved in fintech start-ups, not surprisingly, often ex-
press a great amount of optimism when speaking of their companies.
Joshua Reich, who co-founded the mobile-banking app Simple, wrote:
250
. Alex Hern, Bitcoin Entrepreneur Sentenced to Two Years in Prison, GUARDIAN (Dec.
22, 2014), http://www.theguardian.com/technology/2014/dec/22/bitcoin-entrepreneur-sen-
tenced-jail; Grinberg, Presentation, supra note 252, at 9.
251
. Kim Zetter, Bitcoin Exchange CEO Charged with Laundering $1Million through the
Silk Road, WIRED (Jan. 27, 2014), http://www.wired.com/2014/01/bitcoin-exchangers-ar-
rested/.
252
. Reuben Grinberg, Davis Polk Presentation, Bitcoin: Overview of U.S. Legal Treat-
ment (Feb. 24, 2015), at 9, http://bitcoin-reg.com/docs/All%20Payments%20Expo%20-
%20Presentation%202%2024%202015.pdf.
253
. Id.
254
. Jessica Elgot, Ex-Boss of MtGox Bitcoin Exchange Arrested in Japan Over Lost
$390m, GUARDIAN (Aug. 1, 2015), http://www.theguardian.com/technology/2015/aug/01/ex-
boss-of-mtgox-bitcoin-exchange-arrested-in-japan-over-lost-480m.
255
. Id. See also Tom Hals, Failed bitcoin exchange Mt. Gox gets U.S. Bankruptcy Pro-
tection, REUTERS (Jun. 17, 2014), http://www.reuters.com/article/2014/06/17/us-bitcoin-
mtgox-bankruptcy-idUSKBN0ES2WZ20140617#R6ATUFibO3bgQe3B.97.
256
. Id.; French MtGox CEO in Japan Charged with Embezzlement Amid Bitcoin Fraud
Investigation, SOUTH CHINA MORNING POST (Sept. 11, 2015), http://www.scmp.com/news/
asia/east-asia/article/1857199/french-mtgox-ceo-japan-charged-embezzlement-amid-
bitcoin-fraud.
257
. See Rick Falkvinge, Security At Mt. Gox Much Worse Than Originally Imaged (Nov.
24, 2015), http://falkvinge.net/2014/03/11/just-how-abysmal-was-gox-security-anyway/ (dis-
cussing Mt. Gox’s poor security infrastructure).
64 NORTH CAROLINA BANKING INSTITUTE [Vol. 20
“By not sucking . . . we will win.”
258
However, part of “not sucking” is
building a compliance infrastructure at the outset of a new business ven-
ture rather than treating regulatory compliance as an afterthought. By
understanding and complying with the applicable regulations at the be-
ginning, these fintech start-ups will have a competitive advantage over
competitors that do not take such initiatives. Because some of the fintech
companies or applications are so novel or complicated, those who choose
not to develop a compliance infrastructure at the beginning of their busi-
ness ventures may find themselves bogged down by regulatory head-
aches. Investigations or injunctions may effectively halt the business,
while regulators struggle to determine how it fits within the regulatory
compliance framework. Competitors, particularly the traditional banking
organizations, may use the regulatory uncertainty as a weapon as they
seek to protect their core businesses. Further, by abiding by existing reg-
ulatory schemes or communicating with regulators regarding why those
schemes are not applicable, a fintech start-up is creating a dialogue with
potential regulators that will benefit the start-up in the long run.
259
Hav-
ing an open dialogue with a regulator will help establish trust and avoid
incurring unnecessary legal fees, as well as potentially providing oppor-
tunities for the fintech start-up to influence future policy and regula-
tions.
260
IV. CONCLUSION
Looking back over other periods when potentially disruptive
technologies entered the banking space, a relatively common refrain from
the regulatory bodies was that they wished to avoid premature regulation,
as it might inadvertently stifle development. Perhaps that was simply a
reflection of a more relaxed era. Perhaps it was because the technologies,
although interesting, seemed uncertain to gain customer acceptance, and
much of what went on was quite small and relatively insignificant. Per-
haps it was because banks were major participants in the experiments and
258
. Huang, Banks and Fintech Firms’ Relationship Status, supra note 4.
259
. See Norm Champ, Building Effective Relationships with Regulators, Harvard Law
School Forum on Corporate Governance and Financial Regulation, Oct. 22, 2015, http://
corpgov.law.harvard.edu/2015/10/22/building-effective-relationships-with-regulators/ (dis-
cussing advantages of having contact with regulators).
260
. Id.
2016] NEW WINE INTO OLD BOTTLES 65
the regulators felt comfortable with the window they had on the develop-
ments in the sector.
That era seems to be a relic of the past. Whatever the reasons,
technology firms treading in the banking arena must tread with their eyes
open. To the entrepreneur, the financial rewards offered by digital cur-
rencies, marketplace or peer-to-peer lending, or other new technologies
may seem ripe for the taking, but an unclear legal framework does not
equate to a lack of regulatory scrutiny. The success of many fintech firms
is tied to the firm’s ability not only to be ahead of the technological curve,
but also to have the flexibility to adapt to an evolving set of laws and
compliance obligations. Several years ago, during due diligence on be-
half of a major financial institution of a payments company as a potential
acquisition target, the target proudly announced that one of its competi-
tive advantages was the lack of any state licenses for its activities; this
allowed it to be nimble and quickly adapt its business to changes in the
marketplace. Those days are long over. With digital currencies, the un-
favorable association with money laundering and illicit activities perhaps
made it quite hard to avoid regulatory involvement. With the online lend-
ers, their success seems to indicate that they will not simply be bit players
in the financial world. And with a heightened sensitivity to consumer
protection, it would be unrealistic these days to expect much regulatory
forbearance.
