As a corporation that handles ACH transactions on behalf of others, you may have heard your financial institution refer to you as a “Third-Party Sender.” Common examples of Third-Party Senders include payroll processing companies, rent payment companies, and other bill pay providers. If an entity is designated as a Third-Party Sender, it is subject to certain duties under the Nacha Operating Rules (“ACH Rules”), such as the requirements to have an annual ACH Audit conducted and to enter into specific agreements with its clients (the “Originators”).
A Third-Party Sender’s compliance with the ACH Rules, however, is only one element of the legal and regulatory compliance that should be on its radar. Another critical consideration is whether the Third-Party Sender’s business model subjects it to regulation as a “money transmitter” under federal or state law.
Generally, a money transmitter is a person or entity that receives funds from one party for the purpose of sending them to another party. At the federal level, the Bank Secrecy Act requires money transmitters (a type of Money Service Business) to register with the Financial Crimes Enforcement Network (“FinCEN”). At the state level, it is more complicated because there is no uniform definition of money transmission and no set of uniform exemptions to the licensing requirement that apply among all the states. To further complicate the matter, those engaging in money transmission must be licensed in each state in which they do business, not just the states where they are headquartered or incorporated. Money transmitters are subject to a host of laws and regulations and compliance obligations, including transaction monitoring and report filing requirements, recordkeeping requirements, implementing and maintaining a comprehensive anti-money laundering program, and submitting to federal and state regulatory audits, just to name a few. But despite the burden imposed on money transmitters, operating as an unlicensed money transmitter instead can result in steep civil and criminal penalties.
The topic of Third-Party Senders and money transmission laws is rarely addressed, leaving many Third-Party Senders unaware that these laws exist and could apply to them if they do not take careful measures to reduce their risk of regulation. Being that Third-Party Senders are intermediaries in transactions between Originators and those Receivers that are receiving funds via ACH, Third-Party Senders may unwittingly be engaging in money transmission conduct. Many Third-Party Senders have been operating for years—and some even decades—without becoming registered or licensed as a money transmitter, and they have done so without issue from a regulator. However, Third-Party Senders should not take comfort in any history of non-enforcement by regulators. In recent years we have seen regulators begin to more aggressively enforce their money transmission laws against non-compliant Third-Party Senders, and this is a trend that may continue.
For example, in 2018 the Banking Commissioner of Texas reviewed a payroll company’s business model in the context of money transmission regulation. The company was headquartered in New York and incorporated in Delaware, but was found to be working with clients that were based in Texas. The company provided payroll processing services (whereby it transferred funds from employers to employees), provided preparation and filing of payroll tax returns, and electronically transferred its customers’ funds to the applicable taxing authorities. The Texas Department of Banking determined that the company’s actions met the state definition of money transmission and that there were no applicable exemptions to excuse their lack of licensure. As a result, the company was fined $212,500 based on the volume of transactions and length of time it had been conducting such business without a license. This is just one of many similar enforcement actions by state regulators against a Third-Party Sender.
This is not to say that all Third-Party Senders are subject to money transmission laws, but money transmission laws are something that all Third-Party Senders should evaluate and consider. The stakes for getting it wrong are just too high. And because these laws are facts and circumstances driven, there is not a “one-size-fits-all” answer for Third-Party Senders. Although having to get licensed in multiple states will involve time, paperwork, compliance obligations, and costs, these pale in comparison to the potential liability Third-Party Senders can face for engaging in unlicensed money transmission.