FaceCash Founder Claims New Financial Regulation is Unconstitutional

2/2/12Follow @xconomy

For months, Aaron Greenspan, the founder of the now-defunct mobile payments service FaceCash, has been getting deeper into a legal battle with the State of California over the way it regulates money transfers. And he thinks the implications of his fight go well beyond his startup.

According to an open letter Greenspan wrote to Governor Jerry Brown, a new financial regulation enacted in the state last year “makes it nearly impossible for new companies to offer disruptive products and services. By virtue of the fact that Silicon Valley is in California, this means that innovation in the payments sector in this country has more or less stopped.” In November, Greenspan filed a civil complaint against the State of California, claiming that the new law, called the Money Transmission Act, is unconstitutional because it attempts to regulate interstate commerce, and because the burden of the law outweigh the benefits. Greenspan also claims that arbitrary enforcement of the law violates the 14th Amendment.

Greenspan, 28, founded his company with the aim of changing the traditional payment model, creating a system that allowed merchants to accept payments by scanning barcodes off of shoppers’ phones. The bar codes were linked to bank accounts and worked like debit cards, eliminating interchange fees that merchants pay credit card companies (FaceCash charged its own 1.5 percent fee). They also provided a measure of security for consumers, whose photos popped up with their bar codes.

But as Greenspan was getting pilot vendors and users on board in Silicon Valley, the state enacted the MTA, which requires that companies that work as domestic money transmitters within California obtain a license to operate. Under the new legislation, these companies are required to have a minimum net worth of $500,000, as well as bonds or securities on deposit of at least $500,000 or 50 percent of daily outstanding payments, whichever amount is greater. On top of that, companies like FaceCash that receive money to transmit have to have securities of $250,000.

Before the MTA, only companies that provided international money transfers needed to abide by the deposit requirement, and there was no net worth requirement

After seeing news about the change on the Internet, Greenspan set up an appointment with the state Department of Financial Institutions (DFI) to obtain a license so that he could comply with the law by the time it went into effect on July 1, 2011. Since he met the $500,000 net worth requirement—and could afford the bonding requirements—he was unconcerned.

But the meeting did not go well. Greenspan says he soon found that to ensure smooth sailing for his license application, he had to have more than $500,000 on hand. The problem was that the DFI couldn’t tell him exactly how much more—even though he had provided audited financial statements to the state before the meeting.

“It was a pretty epic disaster,” Greenspan says. “From his point of view I was undercapitalized, from mine I was fine, but I didn’t know the number they needed. It clearly didn’t matter what I told them, they still were not able to provide an answer.”

Following through with an application that might fail would cost Greenspan a $5,000 application fee, but it could also affect his ability to get licenses in other states, he says. If he moved on to apply in say, Pennsylvania, he would have to explain why he failed to get a license in California.

“It’s like car insurance,” Greenspan says. “It’s an important factor.”

Not only that, Greenspan also claims the department warned him that if he continued operating in other states where he already had licenses—Idaho and Alabama—he could face jail time in California for operating without a license. But the law was so new, they weren’t sure.

Greenspan wasn’t about to take chances. The day before the law was set to take effect, he shut down his operations, laying off a full-time programmer and six contractors.

The regulatory troubles have been particularly devastating for Greenspan, who was self-funding the company. The 28-year-old entrepreneur is a longtime programmer who created a precursor to Facebook at Harvard—a Web service he called houseSYSTEM, with a social networking feature called the Face Book. According to Greenspan, Facebook CEO Mark Zuckerberg was an early user.

Months after the meeting, after several e-mails back and forth between Greenspan and the DFI, FaceCash was granted an exemption that allowed the company to keep its headquarters in California, if it kept its money transfer business out of state.

But Greenspan didn’t see this as a real solution. FaceCash would have no way of preventing legitimate customers in the states where it is licensed from traveling to California and using the service there—which might put him in violation again. “We’re in a new age, it doesn’t really matter where your computer is anymore,” Greenspan argues.

It also peeved Greenspan that the exemption only applied to FaceCash, not to any other money transfer companies located in California. One of his complaints is that plenty of other entities-from colleges to startups to major companies—seem to be operating money transfer businesses in blissful ignorance of the MTA. Only because he bothered to check with the DFI, from his point of view, did FaceCash get singled out

Greenspan continued to exchange e-mails with the DFI, at one point listing 34 institutions that he believed were operating without a California license, seemingly with no repercussions.

In November, Greenspan’s company, Think Computer Corporation, filed a civil suit against the State of California, alleging that the MTA violates Article 1 of the U. S. Constitution. According to Greenspan, the law has prevented him from operating FaceCash not just in California, but across the country.

“Interstate commerce cannot be in the domain of each state, it must be a federal function,” Greenspan says. “Just because the states have passed legislation, doesn’t mean they can fill the void.”

Greenspan filed an amended complaint on January 31, and the state has 14 days to respond. The state Department of Financial Institutions does not comment on pending litigation, a spokeswoman said.

Greenspan’s ultimate hope is not only that the MTA will be declared unconstitutional and that he will be able to restart FaceCash in the state, but that the issue of interstate commerce and mobile payments will be dealt with at the federal level. “The whole country needs a better system, whether it comes from my business or someone else’s, we’re in need of a better network,” he says. “Here were are in California where we’re bleeding cash and we’re saying you could use this thing and save so much money, it only it were legal.”

At present, states are allowed to regulate money transmitters as they see fit, and only four states—Massachusetts, Montana, New Mexico, and South Carolina—do not require licenses. In other states, net worth requirements to obtain a license can range from $5,000 to $1,000,000. (Click here for a white paper Greenspan penned about the need for federal regulation.)

“All these things need to get worked out and they’re complex issues, but the first step is getting rid of barriers to competition,” he says.

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