The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which started accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. This is the second in a five part series on how to apply and participate in the sandbox. If you are new to the series, go back and read part one, which gave a little background on sandbox programs implemented worldwide and efforts to create similar programs in the United States. This part two will discuss the benefits of participating in the Arizona sandbox. Part three will examine the eligibility requirements. Part four will explain the application process, and part five will address the rules once you are in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
What’s the Benefit?
The stated purpose of the sandbox is “to enable a person to obtain limited access to the market in this state to test innovative financial products or services without obtaining a license or other authorization that otherwise might be required.” A.R.S. § 41-5602. “Financial product or service” is defined to mean products or services in consumer lending, motor vehicle sales financing, or investment management, which are heavily regulated industries that generally require a state license to operate. A.R.S. § 41-5601(3). For example, Arizona consumer lenders must be licensed and pay annual licensing fees starting at $1,000. Money transmitters are similarly subject to licensing requirements, including annual fees starting at $1,500, and are only eligible for a license if they have a net worth exceeding $100,000 and satisfy a number of other requirements. The Arizona sandbox will allow fintech companies who would normally be subject to such licensure requirements to operate in Arizona without a license.
Less Regulation, Cheaper Costs, Fewer Penalties.
As unlicensed companies, sandbox participants are “not subject to state laws that regulate a financial product or service” except for those specifically identified in the sandbox statute. A.R.S. § 41-5605(F). For example, while consumer lenders will still need to comply with restrictions on finance charges and certain other loan terms, they will not need to provide annual reports and will not be subject to the normal penalty of $300/per violation of the state consumer disclosure requirements. Similarly, vehicle sales financiers who willfully fail to comply with any provision of A.R.S. § 44-281 et seq. would normally be penalized by losing the finance charge due under the loan, but participants in the sandbox will not be subject to that.
Money transmitters in the sandbox will not need to comply with any of the regulations in A.R.S. § 6-1201 et seq. Investment management companies will be exempt from the numerous state requirements set forth in A.R.S. § 44-3101 except for prohibitions on fraudulent practices and “dishonest and unethical practices,” rules governing custody of client funds and disclosure of information to clients, and requirements to maintain books and records in compliance with federal law. Notably, they will be exempt from administrative penalties and the other enforcement provisions in the statute.
The Growing Regulatory Mess: For Example – Money Transmitters.
The costs to get licensed and to comply with even well understood regulations can certainly deter tech companies from pursuing a new fintech project. However, the growing challenge for fintech companies is the lack of clarity about how existing regulations apply to new technologies. For a good example, look at money transmitter laws. Not so long ago, many companies and individuals dabbling in cryptocurrency would not have considered their activities to be subject to state or federal money transmitter laws. The IRS treats cryptocurrencies as property and not as currency. Similarly, the Commodity Futures Trading Commission (CFTC) has been of the opinion as early as 2015 that cryptocurrency is a commodity rather than a fiat currency. The District Court for the Eastern District of New York in CFTC v. McDonnell, No. 18-cv-0361 even recently adopted the CFTC’s view, which might lead a rational observer to conclude that trading cryptocurrency is not the transmission of “currency” subject to money transmitter laws.
Well that clears that up, right? Not so fast. On March 6, 2018, the same day the Eastern District of New York issued its ruling, the Financial Crimes Enforcement Network (FinCEN) published a letter it had penned the month prior stating that cryptocurrency token issuers may be money transmitters, and are therefore required to follow federal money transmitter requirements.
So how is a new cryptocurrency company supposed to proceed in light of inconsistent or unclear federal regulations, not to mention the even murkier application of state-by-state money transmitter laws? This is the type of problem fintech companies will routinely face, as the legal establishment struggles to figure out how to apply existing laws to new technologies that do not fit conveniently into previously established paradigms.
This is where the benefit of the Arizona fintech sandbox really come into focus. You don’t need to answer these tough questions right away. Instead, you get two years to test your product, and in that time you can work openly and collaboratively with the Arizona Attorney General and other governing regulatory authorities to figure out how your product fits into the regulatory framework. These exemptions can potentially provide substantial cost savings to sandbox participants. Most importantly, it will allow you to devote more of your focus and resources on development of your innovative product. Sandbox participants will still need to comply with sandbox-specific disclosure and recordkeeping requirements subject to the oversight of the Arizona Attorney General, which I will discuss at greater length in part four. However, these requirements are much easier to comply with than the normal regulatory regime.
About the Author: Michael Rolland is a member of the civil litigation and commercial transactions practice groups with the law firm of Engelman Berger, P.C. Michael has a special interest in the intersection of technology and the law, and writes on tech law issues.
Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.