A new peer-reviewed paper by Benjamin Lo from Yale Law school launches a scathing attack on the current Balkanized regulatory system in the United States arguing that it is killing innovation.
The paper analyzes state money transmitter laws, noting there is federal level regulation through FinCEN which is generally reasonable. At state level, however, the paper says “definition of money transmission is almost unconstrained… there are no limitations based on transaction size or medium” and “jurisdiction is asserted broadly.”
The paper says federal exceptions from money transmitter laws are not uniformly applied across states, with one exception being banks. It says that “if the startup is not a bank, it must embark upon the difficult path of navigating exemptions and registration requirements in each state it wishes to do business.”
An innovative start up faces a “minefield sown by the states,” according to the paper, which “does not even include the wildly different requirements each state may impose on the same startup.”
It’s not even about regulations themselves as “the central problem… lies not in the breadth of scope but in the diversity of approach. When a new business faces licensure in New York, no licensure in Texas, and confusion in California, it is unable to appropriately plan for growth and capital-raising activities.”
The costs of this Balkanized approach is very high, says the paper, as “the requirement of individual state licensure can kill a startup early in its life, depriving consumers of beneficial innovation in return for few additional protections.” The paper says:
“A recent 50-state survey of money transmitter licensing requirements highlights the near-impossibility of nationwide registration for an early-stage startup. States typically require extensive business plan documentation, audited financial statements, and founder background checks. Many states also have a minimum net worth requirement, which would impede licensure for new startups. Yet these requirements pale in comparison to the capital cost of licensure – the surety bond requirement. Getting licensed in the five most populous states (California, Texas, Florida, New York, and Illinois) would require a minimum of $1.2 million in surety bonds posted with the relevant state financial regulator. The bonds further require an annual maintenance cost, which some have put between 2% and 7%.”
This acts as a barrier to entry, according to the paper, with the primary consideration being affordability of getting a license in all states rather than the meritocratic benefits of new ways old problems can be solved. Shockingly, it states that “a nationwide licensing program could cost up to one-third of the startup’s available funds.” The paper further continues:
“Bringing down the hammer of money transmitter regulation could inconvenience millions of users, either through cessation of service as marketplaces avoid offering services in that state, or through greater pass-through costs as marketplaces contract out basic payments services to companies that already have the appropriate license portfolio.”
It’s a damming verdict on USA’s current regulatory approach after almost a decade of rule by the Democrats. For the new Republican administration, the paper offers many solutions. One approach could simply be to streamline exceptions. Another may be passporting, that is, if a start-up is licensed in one state then it is licensed in all states.
The approach of the last administration has been to bring such start-ups within a regulatory framework that applies to global banks. The OCC has suggested a FinTech charter, which really is just a banking license. An incredible burden for two smart young adults launching a new product in their basement.
Another, more appropriate way, might instead be to streamline the different state’s approaches, or require licensure in one state, instead of replicating the same process in a labyrinth manner at the cost of hundreds of thousands in all states at no added protection for consumers or any increased benefit except for fattened lawyers’ pockets.