My family came here to pursue their dreams and share their success with the people that they care about. That’s why, since landing in the U.S. 20 years ago, my family has been sending money back to the Dominican Republic every single month.
We’re not alone — in the U.S., 40 million immigrants send $123 billion in remittances to their families back home every year. For all of us, this is an integral part of pursuing the American Dream. Entrepreneurs want to build technology that facilitates this ambition.
My partners and I founded Regalii to improve the experience of sending money by creating a worldwide bill payment platform. After being in business for over three years in financial technology, I’ve come to understand why outdated regulation continues to crush the dreams of many entrepreneurs.
Remittances are not significantly faster or cheaper than they were 20 years ago. This isn’t for a lack of trying; there are numerous companies working hard to innovate in remittances, but at the same time financial regulation is increasing the cost of money transfer and stifling the entrepreneurs trying to innovate in the space.
Here are four realities about Fintech compliance that will probably surprise you.
1. You need 48 licenses
To process most financial and/or money transfer activities online, a company must be a licensed Money Service Business (“MSB”). This requires not one, but 48 licenses in addition to compliance with Federal laws. Each of the states except MA, MT, and NM, which are exempt, mandate their own MSB licensing, as does Puerto Rico.
Europe has similar laws, but the European Union has a “passport” system that allows a registered payments company in one E.U. country to get permission to do business in another E.U. country.
There is nothing comparable in the U.S. Some have called for a single national license that could take the place of multiple state licenses. But given the difficulty the current Congress has passing legislation, as well as the country’s increasing tendency to move away from federal preemption, those efforts are unlikely to succeed.
2. $2M just to get started
On average, the initial setup costs are about $40,000 per state, in addition to all of the legal costs. After all is said and done, it’ll cost about $2 million and two years to set up and about $500,000 a year to maintain.
For example, if you apply for an MSB license in California, you get crushed by an avalanche of fees: $5,000 for an application, $3,500 for an “application for approval to acquire control of a licensee,” a $2,500 annual fee, $125 per branch office, $25 per agent office, $75 per hour for each examiner engaged, and a surety bond for at least $500,000 (of which you pay an interest rate of 4 percent per annum).
In addition, some states take longer than others to process licenses. “The New York license has taken us three years and as much money in legal fees as the other 47 states,” one Fintech CEO told me.
To perform due diligence in New York, you need: audited financial statements, a certificate of good standing, bank account details, background checks, credit checks, and criminal records from each and every single executive. Essentially, getting a license in New York means a two-year financial colonoscopy in the 10th circle of hell.
3. No Clear Definitions
So what exactly is defined as “money transfer”? Startups want to follow the law, but the definition of which financial activities require licenses and which ones don’t is extremely cryptic and opaque. Worse, the definitions federally often conflict with the definitions at a state level.
New York’s banking department defines money transfer as the “business of selling or issuing payment instruments, such as checks, or engag[ing] in the business of receiving money for transmission.”
Note that there is no mention of how this applies to digital payments. By this definition, arguably any website that engages in ecommerce or “receiving money” requires a money transmitter license.
In practice, the definition of an MSB business is often counterintuitive. For example, paying your family’s bills is considered an MSB activity, but sports gambling on sites like www.draftkings.com is not.
Because of these nebulous definitions, startups and their investors get hit with scolding subpoenas all the time. With such outdated, unclear rules, many companies don’t even know they’re in violation of a rule until they are contacted by regulators. Union Square Capital’s Fred Wilson says his first interaction with the NY Banking Department was a “punch in the gut.”
4. Penalties can cripple a company
Even if you have the licenses, not crossing every t and dotting every i can result in insurmountable penalties.
Our friends Ripple Labs were recently fined $700,000 by FinCEn. Ripple wasn’t fined because it processed millions of fraudulent transactions but rather because it rejected one transaction from a suspicious customer and did not submit the required Suspicious Activity Report (SAR).
This kind of ship-sinking penalty happens all the time and can often cost millions of dollars. This is enough to kill a seed-funded startup.
No one ever talks about these penalties because it is rarely in a company’s best interest to advertise a mistake. Normally, the offending party sweeps the penalty under the rug rather than tweet it to death.
What’s worse is that the actions being penalized are rarely flagrant in nature — we’re not talking money laundering for cartels here but administrative oversights. For example, the failure to file an SAR, failure to train, or failure to implement policy.
Europe — the land of the free?
At Regalii, we faced all these challenges and luckily found a model that our legal council and that several states’ Departments of Banking agreed is fully compliant. But the whole process wasted far too much time — a crucial commodity to a startup. I spent many sleepless nights struggling with conflicting guidance and worrying that if we got it wrong, in the worst case, I could have ended up in jail.
Because of the unique challenges of running a financial services company in the U.S., many of the best fintech startups choose to start out of Europe. Surprisingly, Europe, home to what many call too much government overreach, is actually much more liberal and precise in terms of financial regulation than the U.S.
The U.S. would be wise to follow Europe’s lead to make it easier to innovate in the financial space and stop killing the dreams of entrepreneurs who are just trying to create better financial tools for Americans.
Edrizio De La Cruz is the cofounder of Regalii, a mobile and web platform that allows immigrants to pay their family’s bills anywhere in the world. He previously worked in private equity and investment banking at J.P. Morgan.