N.Y.-Chartered Bitcoin Firms' Business Boundaries Draw Scrutiny

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By Kery Murakami

Oct. 19 — itBit Trust Company, LLC, a Bitcoin exchange, is attracting the attention of state financial services regulators and drawing fire from rival companies over its claim that it can accept customers from around the country based on a New York trust charter.

If accepted by other states, the approach taken by itBit, one of the first two exchanges to become a trust chartered by New York, would allow it to avoid going through the time- and money-consuming process of obtaining licenses in each state in which it operates as other Bitcoin companies have done.

But it remains unclear whether regulators in other states will accept itBit's argument that it operates only in New York on the basis of a charter there, while accepting customers from other states. Regulators in Texas and Florida told Bloomberg BNA itBit does not have a money transmission license in either state and that they are examining itBit's assertion.

Financial services departments in Washington and Alabama also said itBit has not been licensed in their states. While not discussing whether they are looking specifically at the company, the officials told Bloomberg BNA they're not sure if firms will be able to do business with their residents without obtaining a license there.

Second Bitcoin Trust

A second Bitcoin exchange, Gemini Trust Company, LLC , which received its New York charter Oct. 5, is taking a “very different approach” from itBit and said that it “is in the process of getting licensed in states, such as Texas and Hawaii, that require additional licenses in order to operate, despite the fact that Gemini is a New York trust company,” Gemini CEO Tyler Winklevoss, told Bloomberg BNA in an Oct. 15 statement.

Gemini is holding off from opening for business in a number of states where it is still in discussions with state regulators, Winklevoss said.

The company, though, has attracted the attention of regulators in at least two states, because they have begun operating without getting state money transmission licenses.

Tougher Requirements?

State officials emphasized in a series of e-mails and interviews with Bloomberg BNA over the past month that they have not yet made any determinations about either company. And in interviews and e-mails with Bloomberg BNA, itBit and Gemini said that their approach in becoming New York trusts, while unique, is not only lawful but imposes tougher requirements on them than other Bitcoin companies.

itBit adheres “to all banking regulations required under New York State law, providing customers and regulators in other states with confidence in our business model, bank-level operational strength and regulatory capital levels that are significantly higher than those required under Basel III,” the company said in its Oct. 12 statement to Bloomberg BNA.

Similarly, Winklevoss said, “compliance is one of those critical parts of our business, similar to security, that we just can't afford to get wrong. Making a mistake here threatens our entire business. As a result, we have spent a tremendous amount of time and money making sure we got this right.”

Winklevoss said that in addition to higher capital requirements, the New York charter imposes tougher compliance standards and more stringent inspections by the regulators than money transmission licenses.

But rival companies say the companies are not following the rules.

itBit's Approach

Central to itBit's position is that it operates only in New York, and is not doing business in states such as Florida, Texas, Washington and Alabama.

Likening itself to other legacy institutions, the company's statement said, “all of our business activities occur in the state in which we are regulated and the New York Trust Charter provides us the appropriate oversight of those activities in the state of New York.”

The company said its “primary goal” is “to be the most compliant, well-regulated and transparent firm in the virtual currency industry,” and that if states have questions or concerns it would “work with those states and resolve any concerns they may have.”

But, itBit also said, “as with other trust companies, which have historically accepted customers who approached them from outside of the state in which they operate, we believe that customers from outside of New York State can open accounts with itBit in the state in which we operate and are regulated.”

The company's general counsel and chief compliance officer, Daniel Alter, was formerly general counsel to the New York Department of Financial Services, where he helped direct the agency's virtual currency initiatives, according to the company's website.

Reflecting the fine point that it is accepting out-of-state customers rather than operating outside of New York, the company removed a statement on its website that “the trust charter allows us to operate in all 50 states through one license/charter that is issued by the State of New York but recognized by all states.”

The revised language on the company's website reads it is “the first and only regulated bitcoin exchange able to accept customers across the United States.”

Regulators Take Different View

Regulators may end up with a different view. Washington state and Alabama regulators would not directly address itBit’s position that it is operating only in New York, but said where a company operates matters less in determining whether state money transmitter regulations apply than if state residents are involved in transactions.

“With the Internet and interstate transactions, our focus is on whether a licensee is engaging in money transmission on behalf of Washington residents, not necessarily focusing on the state where the transmission operations take place,” Washington Department of Financial Institutions Consumer Services Director Charles Clark said.

A spokesman for the Alabama Securities Commission said, “If they do business with any person in Alabama, then they are conducting business in Alabama.”

Speaking in general terms, the Alabama state spokesman continued, “Therefore, both companies would be subject to Alabama law if they are conducting business with Alabama residents. If they transmit money for a fee and the transaction originates from a customer in Alabama, then they must register or be exempt.”

Neither state official would say if they are contemplating action against itBit. Gemini has not yet begun operating in the states.

However, Columbia Law Professor Ronald Mann, former assistant to the Solicitor General of the United States, said itBit may have a point in arguing that states outside of New York cannot regulate out-of-state businesses if they do not have an office in their state.

Several court decisions have limited the ability of states to regulate out-of-state companies under the Commerce Clause.

He cited a 1992 U.S. Supreme Court decision, Quill Corp. v. North Dakota, in which the court ruled the state could not impose a use tax for office supplies state residents purchased through a mail-order catalog. The court held that because the company did not have a physical presence, it did not have a sufficient “nexus” to be regulated by North Dakota.

Rivals Question Exemptions

Rival Bitcoin companies, meanwhile, maintain that being an out-of-state trust doesn't excuse itBit or Gemini from having to get money transmission licenses in some states.

While some states allow for exempting out-of-state trusts from their money transmission regulations, a number of others “do not unconditionally exempt out-of-state trust companies from local licensure or registration,” Coinbase general counsel Juan Suarez said in an Oct. 11 statement to Bloomberg BNA.

“We do not understand the New York charter to authorize the offering of money transmission or virtual currency business activity in all other states that regulate those activities,” Suarez said.

Chris Daniel, co-chairman of the global payments practice at Paul Hastings LLPs, also said that itBit and Gemini do not have blanket status in other states because of their New York charter. The two Bitcoin firms will have to take “a state by state approach to determine whether other states agree that a trust company is the right regulated structure to engage in commercial cryptocurrency exchange activity,” Daniel told Bloomberg BNA in an Oct. 9 e-mail.

Daniel declined to name which Bitcoin companies he represents. According to published reports, he has represented Coinbase and Circle Internet Financial, another Bitcoin company.

State Approaches Vary

One state where regulators are examining whether itBit needs a money transmission license is Texas. The state exempts from money transmission licensing requirements “a federally insured financial institution … that is organized under the laws of this state, another state, or the United States,” according to the Texas Finance Code.

While itBit and Gemini deposit customer funds in federally insured banks, a spokesman for the Federal Deposit Insurance Corporation told Bloomberg BNA Sept. 25 that itBit itself is not an FDIC-insured institution. Gemini is also not listed as a federally insured institution.

Stephanie Lowe, an assistant general counsel of the Texas Department of Banking, told Bloomberg BNA that the department “is aware of that argument regarding trust charters and money transmission licensing exemptions.” She declined to comment further in a Sept. 22 e-mail, saying, “it is one of the matters that we are looking at during our current analysis of itBit’s business.”

In Kansas, the exemption to getting a money transmitter's license “specifically lists banks and does not include trust company charters, so the trust company charter itBit has received would not fall under the exemption,” Jay Befort, general counsel of the state’s Office of the State Banking Commissioner, said in a Sept. 23 e-mail to Bloomberg BNA. Befort declined to comment further.

Other states do exempt out of state trusts. But to qualify, regulators in two of those states, Washington and Alabama, said companies need to apply, and itBit has not. Clark said a company also would have to first ask to be recognized as an out-of-state trust.

“They have not done this,” he said of itBit. “For these reasons, a statement that they do not need a license under [the state’s Uniform Money Services Act] does not seem accurate,” Clark said. Gemini said on its blog it is “working with regulators to become operational” in Washington and Alabama.

Gemini Takes Different Tack

Gemini, meanwhile, is distancing itself from itBit's position.

Kaye Scholer LLP partner Evan Greebel, who advised Gemini on its formation and launch, said in an Oct. 14 interview with Bloomberg BNA that state regulators have “different views” on whether the New York trust allows them to do business in their states.”

The company has reached out to regulators in all 50 states to determine if their New York trust charter allows them to operate without getting additional licenses, Winklevoss' statement said. The company on its website says it is “available and open for trading” in 27 states and Washington, D.C. Many of those states have given the company the go-ahead to do business without getting licenses, the statement said.

The company's website says Gemini is not open for business in 23 other states, including Texas, Alabama, and Washington, where the company says it is still working with regulators to get necessarily approvals.

However, Winklevoss' statement acknowledged the company is operating in some states “where discussions are still ongoing or the regulators did not say they could not operate.”

While Gemini says on its website it is operating in Kentucky and Florida, officials there said the company does not have a license to operate in either state.

Florida's Office of Financial Regulation is requesting more information from both companies and hasn't decided how to handle the situation, agency spokeswoman Katie Norris said in an Oct. 7 e-mail to Bloomberg BNA.

Kentucky Department of Financial Institutions Commissioner Charles Vice told Bloomberg BNA in an Oct. 9 e-mail that Gemini, as well as itBit, has not applied for a license. Gemini, however, has asked Kentucky officials to provide an opinion regarding their need to obtain a license, Vice said. The department is reviewing the operations Gemini and itBit but has not made a determination, he said.

To contact the reporter on this story: Kery Murakami in Washington at kmurakami@bna.com

To contact the editor responsible for this story: Mike Ferullo in Washington at mferullo@bna.com