On April 29, 2014, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a series of administrative rulings determining whether five different companies constitute money services businesses under FinCEN regulations.[1]  Four of the five rulings deal with the applicability of various money transmitter exemptions to online services and will be of particular interest to online escrow services and online marketplaces.  Together, these rulings clarify what kinds of virtual currency and payment-related services FinCEN might consider to be money transmission, and they also provide additional definition to the scope of the regulatory exemption for money transmission that is only “integral to sale of goods and services.”

Renting Computing Capacity to Virtual Currency Exchangers Is Not Money Transmission

Ruling FIN-2014-R007 examines the applicability of money transmission regulations to the rental of computer systems for mining virtual currency.[2]  The company described by the ruling rents cryptocurrency mining capacity to third parties, who provide the company with limited information about their mining pool (presumably their public addresses and proportional contribution).[3]  The company enters the mining pool information into its system so that the third parties “benefit[] directly and exclusively from the mining work.”[4]  The company does not benefit from the mining except for its rental fees, and the company never has access to the mined virtual currency.[5]  FinCEN ruled that this activity is exempted from the definition of money transmission because the company only provides the delivery, communication, or network data access services that are used by a money transmitter to supply money transmission services.[6]  Thus, even assuming the third parties renting the computer systems used the proceeds for money transmission, for example, to fund activities as exchangers, the rental activity by itself would not make the company a money transmitter.[7]  This decision appears to apply the same rationale underlying FinCEN’s January 30, 2014 ruling that “[t]he production and distribution of software, in and of itself, does not constitute acceptance of value, even if the purpose of the software is to facilitate the sale of virtual currency. ”[8]  More information on mining activities that are considered by FinCEN to be money transmission can be found here.

FinCEN Adopts a Nuanced Approach to Evaluating Escrow and Payments Services

FinCEN also examined the business models of three companies that facilitated payments between the sellers and purchasers of goods and services through the Internet.  Two of the companies described themselves as providing “escrow services” or “transaction management services.”  The first company, examined in ruling FIN-2014-R004, receives funds from buyers and holds them in escrow in a segregated account at a depository institution until releasing the funds to sellers, subject to the satisfaction of conditions precedent agreed upon by the parties.[9]  The second company, discussed in FIN-2014-R005, offers a very similar Internet service that provides secure transaction management between buyers and sellers for goods and services.[10]  The company’s transaction management services “include assisting buyers and sellers in creating, negotiating, and managing their transactions; dispute resolution, including on-site visitations; item verification on merchandise shipped to the Company’s offices; and document handling.”[11] 

FinCEN ruled that the services offered by both companies fall within the exemption from the definition of money transmission because each of the companies accepts and transmits funds only integral to the provision of services other than money transmission services (i.e., the transaction management services).[12]  The rulings emphasize that “[i]n order to provide assurances to both buyer and seller that the buyer has enough resources to pay for the goods and services, on the one hand, and that those resources will not be released until the transaction is completed according to the parties’ agreement, on the other, the [c]ompany needs to take possession of funds and hold them in escrow until the pre-established conditions for the funds to be paid to the seller or returned to the buyer are met, then release those funds appropriately.”[13]  FinCEN therefore characterized the underlying service provided by the company as transaction management, of which the acceptance and transmission of funds were a necessary and integral part.[14]

FinCEN’s examination of the third company in ruling FIN-2014-R006 offers some insight into the limits FinCEN will place on the application of this exemption to services that facilitate payments between buyers and sellers of goods and services over the Internet.  The company that was the subject of this third ruling holds funds paid by the buyer in its account in anticipation of a transaction, and the seller is later notified that there is a transaction ready for completion.[15]  If the seller agrees to the transaction, a request for payment is sent and the buyer releases the funds, which are credited by the company to the seller’s account.[16]  Sellers also have an option to place a hold on funds as a form of security deposit in connection with a transaction.[17]  FinCEN ruled that while the service does not constitute prepaid access,[18] it does constitute money transmission.[19]  Although the company asserted that “the service offers an alternative to traditional payment transactions that would normally require the use of an ‘escrow account,’”[20] FinCEN noted that the company is “not providing any verification or validation procedure that compares the terms and conditions of the sale with the actual discharge of the obligations of the parties or that would protect the interests of both the buyer and the seller”[21] (i.e., transaction management services).  Thus, FinCEN concluded that the company’s payment and transmission services are not necessary or integral to any service other than the money transmission itself, and the company’s services would therefore be regulated as money transmission.

Together, these three rulings demonstrate that FinCEN does not consider all forms of custodianship over buyer funds in a payment transaction to be a separate service distinct from money transmission.  For a custodian to qualify for the escrow exemption established by the rulings, it must also provide transaction management services, including the establishment of conditions precedent to transactions between users and validation of their discharge, prior to releasing funds.  The rulings also illustrate how fact-specific any determination of whether a given activity constitutes money transmission can be.  As a result, individuals and entities offering online services that facilitate payments between buyers and sellers of goods and services should carefully evaluate the applicability of federal regulations to those transactions.

FinCEN Identifies Factors Distinguishing Prepaid Access from Money Transmission

FinCEN also ruled that the activities of the company in FIN-2014-R006 constitute money transmission rather than prepaid access.  While acknowledging that “prepaid access is similar to the activity in which ‘money transmitters’ engage,” FinCEN stated that “the procedures for directing that funds be transmitted are different, and because of these differences FinCEN treats providers and sellers of prepaid access as distinct [money services business] categories.”[22]  FinCEN then proceeded to discuss the differences from prepaid access in this case, which were that:

  1. While the company’s program requires potential buyers to place funds “on account” for future application to a purchase transaction, those funds are applicable to only one designated seller (as with a closed loop prepaid program), and not split among multiple sellers;[23]
  2. The company’s transactions do not involve an electronic device or vehicle, and do not necessarily employ the use of a corresponding electronic network in processing the payment.  There are no BIN numbers associated with the company’s transactions, and it appears that the transactions can be completed via an internal bookkeeping entry;[24] and
  3. The platform is designed for commercial, rather than retail, use.[25]

It is unclear from FinCEN’s discussion whether all or some of these distinguishing factors must be present in order for a program to be considered prepaid access.  Furthermore, in previous guidance, FinCEN has implied that online access to gift card balances can constitute closed loop prepaid access.[26]  Therefore, for example, an online or mobile service that allows users to store funds on account and use them to purchase goods and services at more than one seller would still need clarification from FinCEN on whether it considers this to be prepaid access or money transmission.  Individuals and entities offering similar services should take note of the distinctions raised by FinCEN and how they may apply to their program.