House Investments & Financial Services – April 24, 2018

The House Committee on Investments and Financial Services met on April 24, 2018 to discuss the following interim charges:

• Study the impact and risks that a large-scale security breach of a credit bureau has on Texans. Identify opportunities to protect Texas consumers and to mitigate the impact of such a breach.
• Study policy challenges in the area of financial technology. Evaluate the concept of a “sandbox” as a regulatory approach for enabling innovation and the feasibility of implementing such in Texas. If appropriate, make recommendations for possible legislative action to foster innovation in the finance industry.

In addition to these charges the committee also heard testimony on cryptocurrency and the potential role it may play within the financial sector in Texas.

This report is intended to give you an overview and highlight of the discussions on the various topics the committee took up. This report is not a verbatim transcript of the hearing; it is based upon what was audible or understandable to the observer and the desire to get details out as quickly as possible with few errors or omissions.

 

Testimony on Cryptocurrency

Panel 1

Marshall Long, Self

• Described his experience consulting with companies and governments concerning cryptocurrency.
• Big states have already taken steps toward allowing cryptocurrencies take hold.
• To keep it simple, a blockchain is a secure database that cannot experience change unless all stakeholders agree.
• Blockchains can be applied to help automate the following sectors: accounting, legal, and real estate.
• The security benefit of blockchain is that it allows owners to pull their data. For example, they could use their smartphone to access data without needing the data to be stored anywhere.
• Most financial restrictions in Texas arise from the Bank Secrecy Act and anti-money laundering concerns.
• With cryptocurrency, automating these regulations becomes easier.
• Parker: Tell us about what Wyoming is doing in FinTech.
  • Wyoming launched five bills that have loosened regulations on “Sandboxes”. If people want to launch these FinTech tools, that has become easier to do.
• Parker: Can you speak to how much more secure data will be in this method?
  • Instead of making one large honeypot of data for attackers to hit, there are multiple storage spaces. Overall, it is much more secure.
• Parker: You envision this to be voluntary for consumers?
  • Sure, especially with the Facebook concerns, people want to have the ability to own their own data.

 

Daniel Wood, Self

• Cryptocurrencies are not a significant factor in the financial sector right now.
• As a medium of exchange, until it is backed by governments, don’t worry about cryptocurrency.
• Still, governments must worry about regulating it as either property or as having monetary value.
• Blockchain and distributed ledger are synonymous.
• A blockchain is a public ledger, a copy of which is on every member of the network’s computers, therefore everyone has a copy of the ledger. For example, every transfer of Bitcoin is tracked by the blockchain.
• This replaces a trusted intermediary. Right now, if I want to transfer money I will go to a bank. Blockchain replaces the bank.
• False entries are very difficult. You would need the consensus of the network for entry into the block.
• An example of something that could be stored in blockchain are voting records.
• In July 2016, a bank in Canada used a distributed ledger to send money to a bank in Germany in 8 seconds at a cost of pennies. BBVA did the same thing a year later, making 50 transfers from Spain to Mexico at a cost reduction of 81% than the system they currently use.
• Tests need to be done to see how a distributed ledger would scale to the US economy.
• Parker: With the Faster Payments Coalition being started by the Federal Reserve, will there be an increase in speed in which it comes to market?
  • The distributed ledger is already ramping up. No cryptocurrency is in the US legal tender so that will spread only to the extent that governments adopt it.
• Parker: What is the time difference between the 8 second transfer as opposed to the traditional wire transfer today?
  • Roughly 3 days.
• Parker: Is there a technical way to protect one institution from seeing another’s transactions?
  • There is a technical solution, but I do not understand the technical aspects. My understanding is that it is an encryption type solution.
• Parker: It seems you should be able to reverse a charge, is that correct?
  • Bitcoin is a lot like a cash transaction. When I hand you $5 cash, it now belongs to you. With automated clearing house and credit payments, there is a mechanism to roll that back. The blockchain does not have that and there would need to be a subsequent transaction to solve the issue.
• Johnson: Does a cryptocurrency have a blockchain aspect? Explain how they relate to a distributed ledger.
  • Cryptocurrency are digital tokens that people use as currency. A Bitcoin is a type of cryptocurrency. You need the blockchain to distribute cryptocurrencies. The distributed ledger is a generic term for blockchain.
  • The whole system is like US mail. Cryptocurrencies are the magazines you get in the mail and the distributed ledger is the network of mail offices that you use to receive mail.
• Johnson: What are some things the Legislature should be thinking of on the currency side?
  • The debate about whether cryptocurrency is money, security, or personal property is what regulators already and will have to struggle with. How we classify it determines how we regulate it.
  • Determining when someone has possession will also have ramifications for property law, inheritance, etc.
• Stephenson: How do we convert cash to the token?
  • There are companies that are set up as exchanges that will act as a middle man.
• Stephenson: That means different currencies can be exchanged for the same cryptocurrency?
• Stephenson: So, what will the effect of that be?
  • A lot of changes will happen. We are trying to explore what will happen next. Until a government says you can pay taxes with a cryptocurrency, for example, it might not be adopted.
• Parker: What is the going rate of exchange?
  • Its less than 1%.

 

Justin Newton, Self

• The internet caused a wave of information and value creation.
• I see blockchain as the natural successor to the internet.
• This system is open and permission-less to use and competes with systems that are very closed and permissioned.
• If theories prove correct, we can see inclusion, innovation, and value creation.
• Texas is very strongly situated to lead on this technology because of its light regulatory approach.
• New York has already floundered with the BitLicense and have driven innovation out of their state. Companies cannot take advantage of new blockchain services.
• California has not implemented regulation, but they do not have a strong history of taking a light regulatory approach.
• Wyoming has already taken steps to support innovation in this area with a series of legislative packages.
• But Wyoming does not have the technology depth that Texas does. A similar response here could have a much stronger response in attracting innovators to the state.
• This is an approach being played out internationally as well. Singapore and the UAE are creating environments in which creators can thrive because they see this technology as something likely to change the world next. Their goal is to attract the talent to their country.
• We are working with a company called Bit in the Caribbean that is working with local banks to digitize local fiat currency onto the blockchain. This is a government backed aspect. They are doing this because it allows for greater financial inclusion. It also reduces the cross-border transaction timeframe.
• Blockchain can assist in the following areas: title research, supply chain, self-finance, self-sovereign identity, health and medical record systems, copyright enforcement and management, data security and integrity.
• Tools exist today to appropriately control these technologies.
• When regulating, I recommend regulating the action and purpose of the transaction, not the technology. If you legislate at the blockchain level itself, you will carve yourself out of international competition. Legislating at the application layer will allow you to require people follow the same rules but in the right place.
• There are tools to track where a coin is coming from and what transactions it has gone through before.
• Parker: Who created the underpinnings of blockchain today?
  • That is difficult because it goes back to who created Bitcoin, the first public blockchain. Bitcoin was originally created as a released white paper and then an open source software package around that white paper. These were released under what we believe to be a pseudonym called Satoshi Nakamoto. I do not know who that person is. I might know people who know who that person is, but they aren’t talking.
  • Who created the tool is not the important question, the direction it can be taken in is the important question.
• Parker: Your company provides your tools to anyone who would want them in the world?
  • We primarily provide them to startups operating in this space, but we also do work with financial institutions.
• Parker: How is First Caribbean reacting to your work in Barbados?
  • I am under a non-disclosure agreement with CIBC.
• Parker: Can you speak to GDP lift? What specific components are driving it?
  • The first piece is financial inclusion aspect. If you can get from 20% to 80% of people participating in the economy, services can be cheaper to provide and distribute as a government. The second piece is inter-island financial transfer. Today, in order to transfer money between islands, individuals would need to go through a middle man. Blockchain removes that.
• Stephenson: What about freedom? What are we giving up?
  • One exciting thing about this technology is that it was built by a community that believes in individual freedom. Blockchain technology removes the ability of a third party to intervene in my sovereign transactions or data.
• Stephenson: Lets put this a different way, are we creating a society in which sophisticated people as yourself will be above the average guy who works?
  • If people like me are building something that isn’t benefitting everyone else, then we are going down the wrong path. One of the reasons I got into this-
• Stephenson: Let me interrupt you there, let’s say your system works. Will it effect people who do not want to be involved?
  • Everyone uses the internet today, whether they wanted to or not 15 years ago, because we made it simple and easy for them to use. For them, it became better than what the alternatives were before. The goal of everyone building in this space is to do the exact same thing here- to build tools everyone can use. The thing that got me into it was not the opportunities it could create for myself, frankly I have access to top notch financial services in the US and have no problem using them. The things that excited me about this technology are the tools we can create for people who don’t have access to the same opportunities I do.

 

Lana Reeve, Maco.la Capital

• We see this as a paradigm shift.
• There is a lot of confusion around this technology. Because of that confusion, regulators are harming its potential.
• A token is nothing more than a contract. Trying to regulate digital paper does not work.
• Bitcoin is purely a method of exchange.
• We need a regulatory framework to encourage blockchain’s spread to Texas.
• Current regulation may hamper the fostering of blockchain technology. For example, in securities law, you can have an exemption to the 2,000-person trade limit, but only if you use a transfer agent. With blockchain you do not need a transfer agent.
• Parker: Tell us about Maco.la.
  • It is a new fund, formed in January. We are exploring investment opportunities involving blockchain. We believe everything will eventually go on blockchain.
• Parker: How big is your investment window?
  • We are looking at early stage startups. It is more of a 3-5-year horizon.
• Parker: You’re probably trying to have an investment window of less than 24-months?
• Parker: Is there a certain number of transactions you’re trying to find?
  • There are so many. Finding the talent to get it done is difficult.
• Parker: Is it a blind pull of capital?
  • We are looking at all opportunities in block chain.
• Stephenson: Do you have a specialist from the Treasury talking with you?
  • We are not investing in currency, only companies that enable blockchain.
• Stephenson: Let me ask a different way, has the IRS or Treasury gotten involved where they’ll want their piece of the pie sometime?
  • We are making traditional investments.
• Stephenson: I’ve never seen the government not want to get more money.

 

Questions to Panel 1

• Parker: Long, I think you can speak to some concerns originally raised by Daniel.
  • Long: There is already a banking consortium called R3. I coauthored a protocol that can help facilitate the private transactions that are riding on Bitcoin. Bitcoin is just one example. It depends on the technology of your choosing.
• Parker: Daniel Wood, with regards to IP, to what extent can companies protect those new IPs?
  • Wood: Consider the underlying tech like open source software which someone can modify to meet their business plans- it therefore becomes not open source. It is protected like any IP but just stems from an open source technology.
  • Newton: There are groups in the industry that have agreed to an intellectual property mutual protection act. Where they will create IP and put it in a pool where they can share it amongst collaborating companies while also protecting each other from outside suits.
• Parker: We appreciate the dialogue and look forward to working together to see how we can foster the development of this technology in Texas.

 

Panel 2

Charles Cooper, Texas Department of Banking

• All states are trying to determine if cryptocurrency should be regulated.
• Texas DOB looked at the statute and determined that cryptocurrency is not money since it is not government sponsored.
• Cryptocurrency makes just 1% of all currency transfers.
• A year ago, cryptocurrency trade was less than that of baseball cards. But that is probably not true anymore.
• We do not have data on amount of cryptocurrency transactions in Texas because it is not regulated here.
• Regulation of FinTech is a hot topic in all states. Historically, we do not regulate technology. We regulate industry.
• Parker: Are there any Texas banks participating in the consortium?
  • Not that I know of, but I will try and find out.
• Parker: Have you heard any concerns from Texas banks?
• Parker: This is a fascinating move away from typical structures. What are your thoughts on how the fed is looking at this?
  • The pressure to have a transaction settled in a shorter period of time has helped move the issue.
• Parker: What are the implications for our banking system?
  • Faster movement brings the concern of truly settling up.
• Parker: Is it too early to make an assessment on whether this is a safer, more reliable method of exchange?
  • It is too early to say.

 

Travis Iles, Texas State Securities Board

• It is important for us to specify what we regulate.
• Currently, the agency does not intend to regulate cryptocurrency itself. We also do not regulate the technologies, such as blockchain.
• Our interest in cryptocurrency arises in where promoters are using cryptocurrencies in passive investments. Our interest is in securitized currencies.
• In 2016 Bitcoin sustained catastrophic changes in value.
• Our enforcement program has been monitoring cryptocurrencies and how they could be marketed to retail investors.
• We noted an increase in opportunities being made to Texas investors. This trend was to be expected.
• In December of last year, we started a heightened investigation of folks targeting our retail investors. The review made clear that these opportunities were fraudulent in nature- often cloaking the identities of the promoters and concealing other info.
• 32 investigations were opened and none of those programs which were investigated were registered to sell securities in Texas. 19 of the 32 associated their program with Bitcoin.
• For some of these promoters, the association with Bitcoin was nothing more than asking for money in exchange for Bitcoin.
• 30 of the promoters were using social media to advertise. At least 5 touted their currencies as being risk free.
• 1/3 of the promoters provided physical addresses.
• One of the most egregious things we found was an anonymous group which provided personas to individuals which would help them market the program. In taking action against that company, it was found they were stealing the identities of lawyers in Texas and touting them as their legal team.
• Due to the investigation, Texas has become the first regulator to take action against one of the securitized cryptocurrencies in the country that was based on fraudulent investment schemes.
• The agency works continuously in the cryptocurrency area.
• Enthusiasts have welcomed our efforts.
• Parker: Do your investigations take place across the state or mostly in metropolitan areas?
  • We investigate across the state, but this activity is situated majorly in metropolitan areas.
• Parker: Is there information on your website about these cryptocurrency frauds?
  • Each of the actions we took are broadcast on our website. Also, the cryptocurrency report I referred to has been put on our website.
• Parker: Any idea of the amount of money attempted to be fraudulently transacted?
  • We suspect there is a good deal of money going out. Whatever the fraudulent capitalization was, it was next to zero.
• Parker: The SEC has designated cryptocurrencies as securities?
  • Chair Clayton was quoted as saying that he would have a hard time seeing it not as a security. We will pivot to what the underlying facts are. We like the analogy of the transaction being a contract.
• Stephenson: If its not money or a contract then it must be a security. It will be interesting for a company who has invisible capital.

 

Study the impact and risks that a large-scale security breach of a credit bureau has on Texans. Identify opportunities to protect Texas consumers and to mitigate the impact of such a breach.

Ann Baddour, Texas Appleseed

• The Equifax breach affected roughly 60% of Texas’ adults.
• Experts say they haven’t seen the data sold- but who knows when it will be? A lot of the identifying data stays with us for life.
• Identity theft in 2016 impacted about 15.4 million Americans and led to financial losses of roughly $16 million.
• We looked at how other states have addressed this issue. A consistent plan of attack is a credit freeze.
• A credit freeze stops any new credit accounts from being opened in your name.
• The freeze costs $10 and must be done at all three credit bureaus to be effective.
• To withdraw the freeze, it costs another $10.
• Various states have enacted free credit freezes.
• One of the controversial practices that happened in the wake of the breach was a where a free credit monitoring service forced users to enter payment information with the stipulation that unless they canceled the service by a certain date, they would be charged for the service. A law prohibiting this was passed in Oregon.
• Some states have put into effect more strict legislation concerning breach notification than Texas has.
• Following the breach, Equifax has profited $4 million off credit freezes. Legislation against this should be enacted because they should not profit off their mistake.
• There are two types of fraud alerts- 90-day and 7-year (if identity theft can be documented).
• There needs to be ways of identifying if fraud alerts can be issued in a more user-friendly manner.
• We need to ensure people can challenge fraudulent reports on their credit.
• A default judgement can be issued in Texas without the need to verify the debt.
• Proactive protections need to be pursued.

 

Matthew Schneider, VMWare

• Government and enterprise are using more technology services to better serve the consumer- but these new services increase the amount of data collected on the user and therefore increase the threat from attack.
• The impact of these attacks generates more interest in preventing bad actors from stealing information.
• Despite high spending on defense, the number of attacks and breaches has increased.
• We believe in an application-based approach which focuses on protecting the data itself. A transition from protection of the database to protection of data itself is fundamental for the future of data security.
• The most basic action that should be taken are: least privilege access, encryption, micro-service authentication, multi-factor authentication, and patching of services.
• These concepts are not new and are supported by industry.
• The key to this approach is the combination of layers.
• Having all these principles in place would not only mitigate attacks but could have possibly shut down the attack entirely.
• Explained how lack of these principles led to the Target breach.
• To understand the Target breach, you need to know that the attackers did not start with Target themselves. They looked at vendors that listed Target as a customer. Then they began spearfishing campaigns to break into the vendors networks. Once they were able to get into one, they used that vendor’s network to get into Target’s network. They were able to get inside via a door Target opened for business purposes.
• This articulates the value of multi-factor authentication. The attacker only needed the username and password of the vendor to get into the system.
• The attackers were able to move from various stores without being stopped by the need to provide new security information.
• Parker: If you put in place the proper levels of protection, you can easily thwart these major breaches we’ve seen recently?
  • The bad guys will find a way into your network. Putting more alarms within the network will reduce the damage they can cause.
• Parker: To what extent do you believe Texas agencies are prepared?
  • Many of the agencies in the state have been great partners. But we need to recognize that this is an evolution. Many of these networks have been in place for decades.
• Parker: Are agencies complying with best practices?
  • Their action and intent is in the right direction.
• Parker: Give us your perspective on how to protect data as we move to a new realm of technology.
  • The fundamental principles of cyber hygiene are the same over time. Increasing layers of defense will protect us as we implement new technologies.
• Stephenson: Let me ask what you said, but another way: Are the agencies in Texas protected? Its that simple.
  • No one is protected. There is not an agency anywhere-
• Stephenson: Let me put it another way, are you confident your firm is telling agencies they need to do A,B,C to stay current?
  • Yes, we work with them daily.
• Burrows: For the financial institutions you serve, is there potential civil liability from customers and is that insurable?
  • I will defer concerning insurance. The real question is whether there are different levels of liability concerning how the data is acquired/required.

 

Tim Morstad, AARP

• Explained heightened risk of identity theft due to Equifax breach.
• 2016 saw a 16% jump in information stolen from Americans when compared to 2015.
• Federal Trade Commission (FTC) reports that it took credit agencies on average 6 months to correct credit reports following a data breach.
• Various bills have been considered to help combat identity theft.
• Giving consumers more control over their credit reports is a plan the state should pursue.
• Credit freeze fees are a barrier for persons who wish to take the proper steps to protect themselves.
• Equifax has made credit freezes free until June of this year, but Equifax is not the only credit bureau. Now that the information is stolen, the thief can apply with another bureau to steal someone’s credit identity.
• Our Fraud Watch Network was created in response to cyber-breaches. It provides members the ability to learn what they must do post-breach.
• According to the FTC, persons aged 50-59 are those most likely to be targets of identity theft. Individuals 50+ hold the largest assets.
• Parker: It is only appropriate that an entity, when a mistake is made on their watch, should not gain additional revenue as a result of that.
• Parker: When these freezes are put in place, do customers still have the ability to transact business or are they locked out from credit related purchases?
  • Ann Baddour: If you freeze your credit at a single bureau, it will likely not affect purchases. If you do not freeze all three, it does not protect you. If you did freeze all three, you would need to unfreeze the one that the credit provider utilizes.
• Stephenson: Why isn’t there more security for those 50 and up? They’re more likely to get hit!
  • Ann Baddour: That is something that can be built into their obligations.
• Stephenson: That would be a payment I would be willing to make so they could watch mine more.

 

William Perkins, Self

• I have tried to contact Equifax seven times but receive no real action on what I specifically ask for.
• Credit card companies can request data from Equifax and they will receive a large amount of personal data back. It is unclear how much of this data was stolen in the Equifax breach.
• On the form that companies fill out to request the data, they must agree to follow the Fair Credit Reporting Act of 1970.
• That Act permits companies to use credit data, but only in specific manners. Equifax has obviously not followed that protocol.
• In my opinion, Equifax has not followed the Fair Credit Reporting Act.
• I wrote to my representatives concerning this.
• The CEO of Equifax testified before the US Congress in 2017 that consumers would have more control over who is accessing their credit score. He was fired after saying that. I’m not sure if there is correlation or not.
• Consumers need to have more choices concerning who gets their data.
• Equifax has not responded to my concerns regarding who gets access to my data.
• On May 25, the General Data Protection Regulations will come into force in the European Union. Consumers will be able to tell companies what data can be collected and utilized- allowing the consumer more control over their data.
• The FTC is not doing anything on this.
• The US House believes this data was stolen by a nation state and will not appear for sale on the dark web but will be used in another way.
• Parker: There is nothing more powerful than individuals sharing their stories with us. Have you seen any negative effects from the breach or is it more of a ticking time bomb?
  • It is more a time bomb.

 

Charles Cooper, Texas Department of Banking

• I have before addressed this committee concerning cyber security.
• Cyber crime continues to grow at an alarming pace.
• In 2010 the Department created the Texas Bankers Electronic Crime Taskforce in conjunction with the US Secret Service.
• The Department participated alongside federal agencies in the creation of the Cybersecurity Assessment Tool (CAT), released by the FFIEC in June 2015. This guides institutions through the minimum standard of ensuring cybersecurity.
• It identifies the amount of risk posed to a bank through technology.
• Explained the history of the Equifax breach and the breadth of the fallout.
• We held an all-states call to determine which states had the authority and expertise to investigate Equifax.
• Initially, the company tried to delay our entry into the examination.
• The breach has left more than 200 lawsuits against the company and many regulatory inquiries.
• The Texas Finance Code authorizes the Department to examine third party service providers. Credit reporting agencies fall under the statute.
• The decision to examine this company was not taken lightly, but we did it because we felt our federal partners were not taking up their part of the bargain and that it was necessary to protect our citizens.
• We are in the final stage of the investigation.
• Equifax has hired numerous consultants and professionals to review their current practices.
• Parker: Do you feel Texas is in a state of readiness to address future attacks?
  • There have been several changes in management. We believe they are taking positive steps.

 

Eric Ellman, Consumer Data Industry Association

• Expressed frustration with Equifax’s inability to prevent the breach.
• Listed various federal acts, including the Federal Fair Credit Reporting act, which heavily regulate their industry, as well as various agencies that enforce that regulation.
• Equifax has made mistakes and acknowledged those mistakes before the public.
• Credit freeze fee removal is a trend across the nation. We will not stand in the way if Texas follows suit.
• We will stand with the state in reviewing what it takes for consumers to prove they are identity theft victims.
• A credit freeze can be placed by a consumer to prevent the opening of new credit accounts at any time.
• Parker: Can you have a system in which a consumer can place a freeze which will block all new accounts except for one that the consumer chooses?
  • There are states which have chosen a similar route.
• Parker: Please get me specifics on that. I want to know if this is something the industry can fix or if there needs to be legislation.
  • Equifax got a lot of unfavorable criticism following the attack. Following the media attention, they extended the credit freeze until June of this year. We do not oppose a statute which makes all freezes free for consumers at all times.
• Parker: Tell me about the possible products that would enable a freeze for a longer period.
  • Under federal law, consumers have the right to a fraud alert. Under state law, consumers have the right to a credit freeze. A fraud alert acts as a stop sign for a lender who must then verify the consumer’s identity. A credit freeze prevents the opening of new credit in the consumer’s name without their consent. The freeze can last forever, but the alert has an expiration.
• Parker: What do you expect the changes in protocol to be, Charles Cooper?
• Cooper: Experts say the stolen data has not been utilized at this point. This is something we will all have to work on.
• Parker: Do you believe this breach was caused by a nation state?
  • Cooper: With due respect, I do not wish to answer.

 

Study policy challenges in the area of financial technology. Evaluate the concept of a “sandbox” as a regulatory approach for enabling innovation and the feasibility of implementing such in Texas. If appropriate, make recommendations for possible legislative action to foster innovation in the finance industry.

Daniel Wood, Self

• Regulatory innovation can be categorized in two ways- sandboxes and on-ramps.
  • Sandboxes are a live test environment.
  • The on-ramp is more along the lines of helping smaller companies get from inception to market.
• Getting to market first is huge in competitive advantage. In financial services, there are a lot of regulations which slow down this process.
• The U.K.’s Financial Conduct Authority pursued the sandbox idea. They had a wide variety of companies involved that were testing financial service products.
• The FCA concluded that there was a 90% success rate in companies moving from sandbox to market.
• In this sandbox, the regulator works with the company to determine how much regulation is required.

 

Ann Baddour, Texas Appleseed

• FinTech is simply attaching technology with financial services.
• The sandbox approach is relatively new- our main concern is consumer protection. When a regulator is essentially allowing the product to go to market, they are providing state approval.
• Backend guarantees that if things go back, people are protected.
• Consumer benefit needs to be a part of the assessment.

 

Charles Cooper, Texas Department of Banking

• We are trying to minimize the time it takes to get a money transmitter license
• Consumer protection laws states will fall away if congress takes over in this process.

 

Stephanie Newberg, Texas Department of Banking

• Money transmission is the receipt of money in exchange for a promise of making that money available at a different time/location.
• Money transmission has advanced across new technology platforms.
• Getting a money transmission license is extremely difficult- it is not a market for a small company.
• Our money transmission statutes have two purposes- to protect consumer’s funds and prevent money laundering, drug trafficking, and terrorist financing.
• We came up with the idea of a startup license which could be held for up to three years.
• These would be for innovative financial services and products.
• The startup would need sponsorship from a bank or a licensed money transmitter.
• It would include an agreement concerning how much oversight the sponsor will provide and what will the startup provide.
• Application process for startup licensee would be condensed and less strenuous- we would lower the net worth and financial statement requirements.
• Burrows: Do we have a tiered licensing system right now?
  • No, there is one money service business license.
• Burrows: No matter what, no matter the number of transactions people are engaged in, there is the same minimum net worth requirement?
  • It only goes up from the 500 as your transaction volume goes up.
• Burrows: So, it does go up after the 500.
• Burrows: Rather than getting into a sandbox concept, make newer lower tiers for lesser transactions, and not worry about the complicated partnership and everything else. I assume the barriers of entry being lower would help.
  • That is another idea.
• Burrows: What are the pros and cons of going down rather than having the sandbox idea?
  • There are other requirements like audited financial statements and things like that. We tried to figure out a way where we could lessen those. Another thing is the bank secrecy compliance which startups really cannot do. If the sponsor can help in compliance, it would help the startup plenty.
  • If we lower the standard and you can only do 5,000 transactions, you will not be profitable with all the other requirements.
• Burrows: Perfect, thank you!
• Parker: You need to give people a farther horizon, I agree. With regards to the sponsor relationship, what is your protection for the startup working with the startup?
  • The sponsor would ultimately be responsible for losses of the consumer. Any loss with activity covered by the agreement, we would require a bigger bond to protect consumers.
  • Cooper: Many of the large financial institutions make investments in these companies to get the next deal. This allows them to move to market quicker because they get a less restrictive license.
• Stephenson: I’m going to play auditor. This startup company will have some initial capital, the big sponsor will want something for that.
  • I thought they would get a percentage or monthly fee and then a percent of the profit.
• Stephenson: It would be predetermined before they agree?
• Stephenson: There will be a lot of startups who want to merge with a sponsor. You’d better look at that.
  • We would have to vet the sponsor to ensure the sponsor is large enough to take the startup.
• Stephenson: I’m just saying is that the innovative idea is what they’re really buying.
• The sponsor can help provide the startup a compliance officer.
• We will conduct examinations of the startup to protect each beneficiary.
• Our general counsel gave the example of receiving your driver’s license- first you must have other persons in the car with you before you can drive alone.
• Gave examples of bills from Illinois and Arizona that provide for similar programs.
• We believe our idea can create economic opportunities.
• A sandbox period must have an established test period, must define “innovative”, what products and services will include, adequate consumer disclosures, limits on consumer losses, anti-money laundering programs, safeguard the consumer’s personal data, and a tailored regulatory response.
• Parker: I applaud the efforts of the Department and look forward to learning how we can advance this further.
• Stephenson: I just suggest something. The sponsor thing, you might want to check with American Institute of CPAs concerning disclosure of auditing. They might have to disclose the sandbox.
  • Ok, we vetted this idea with various groups.
• Parker: I see the applicability of sandbox in a whole lot of areas outside of financial services.