On August 8, 2016, California Senator Holly Mitchell revived California Assembly Bill No. 1326, which was originally introduced by California Assembly member Matt Dababneh in February 2015 and had been inactive since September 2015. On August 11, 2016, the amended bill was referred to the Senate Rules and Banking and Financial Institutions Committees. According to Mark Farouk, a spokesman for the Assembly Banking and Finance Committee, a significantly modified version of the amended bill will likely be reintroduced in January 2017.
The amended bill was a substantial improvement over the original bill, as it appeared to remove the draconian and generally unproductive anti-money laundering requirements that would have applied to all virtual currency businesses, including businesses that never handle any customer funds. However, due to a significant amount of vagueness in the legislation, the amended bill “drew fire from virtual currency advocates who had previously grown to applaud how it differed from the New York BitLicense – notably in its lack of new anti-money-laundering requirements.” If the new bill can remedy this shortcoming, California will have struck a solid balance between the need for regulation and the desire to protect customers without harming innovation.
The Virtual Currency Act in the original bill provided for a strict licensing scheme that could have suffocated virtual currency innovation in California. In contrast, the amended bill allows virtual currency businesses to operate in California through January 1, 2022, as long as they participate in the State’s Digital Currency Business Enrollment Program (Enrollment Program). Additionally, the Enrollment Program does away with minimum capital requirements and costly bonding or insurance requirements, which were included in the initial bill and in most attempts in other jurisdictions to regulate virtual currency businesses, including New York’s BitLicense. However, the Enrollment Program still ensures that the State monitors the operation of virtual currency businesses as enrollees must respond to surveys, investigations, audits, and questionnaires “for the purpose of [allowing the Department of Business Oversight to] gather information and to ascertain detailed facts about the enrollee’s business model, capitalization and net worth, and cybersecurity, among other things.” It also requires enrollees to maintain records of all marketing and advertising materials, accounts, books, correspondence, and other records upon request to “facilitate the commissioner’s fact-gathering.” Failure to comply with these requirements is grounds for imposing additional fines and penalties or being disenrolled from the Program. For the protection of enrollees, all materials submitted to the Department of Business Oversight will be held in confidence and are not a matter of public record.
The amended bill also contains more expanded consumer protections than the Virtual Currency Act. For example, the amended bill requires specific disclosures to be provided to customers in English and any other language spoken by a majority of customers, and it requires businesses to provide customers with receipts containing specified information for each transaction. It also prohibits advertising products, services, and activities without disclosing that a “government agency has not reviewed the safety or soundness of the business or digital currencies,” and “prescribe[s] a fine of $100 for each violation of the provisions relating to receipts.” The Enrollment Program also authorizes a superior court to have jurisdiction over enrollees by allowing it to “appoint a receiver, monitor, conservator, or other designated fiduciary or officer of the court for a defendant or the defendant’s assets,” as well as authorizes the Commissioner of Business Oversight to “include in civil actions claims for ancillary relief, including restitution and disgorgement, on behalf of a person injured, as well as attorney’s fees and costs, and civil penalties of up to $25,000” for up to four years after the purported violation occurred and “refer evidence regarding violations of the bill’s provisions to the Attorney General, the Financial Crimes Enforcement Network of the United States Department of the Treasury, or the district attorney of the county in which the violation occurred, who would be authorized, with or without this type of a reference, to institute appropriate proceedings.”
Although the amended bill removes stringent licensing requirements
, while still protecting consumers and making sure companies have appropriate anti-money laundering procedures in place, it still appears to be overinclusive due to its vague definition as to what types of businesses would be required to enroll in the Enrollment Program in order to operate in California — businesses “offering or providing the service of storing, transmitting, exchanging, or issuing digital currency.” As an initial matter, this broad definition does not address one of the most fundamental tenets of any successful virtual currency regulation—that of money transmitting. Money transmitter licenses, which are required for California MSBs (money services businesses), protect consumers by preventing money laundering in addition to maintaining public confidence in financial institutions and preserving the health, safety, and general welfare of the public. However, California has yet to grant the same types of licenses to virtual currency businesses or allow them to operate without one. This amended bill provides no direction in terms of whether certain types of virtual currency businesses are exempt from the need to obtain a money transmission license, the process for which is quite burdensome and costly. Moreover, many of these businesses could not be used for money laundering because they do not hold customer funds, yet they could still be required to obtain a money transmission license. Thus, many virtual currency businesses would be in the same limbo they have been in for some time now.
Further, “storing” is broadly defined in the amended bill as having “custody or control of digital currency on behalf of others[, which includes] … having access to a customer’s digital currency credentials, the ability to execute a digital currency transaction on behalf of a customer, or the ability to prevent a customer from effecting a desired transaction of digital currency.” This non-exhaustive list of ‘storing activities’ includes businesses with partial or temporary access to their customers’ information that cannot complete or prevent transactions until the customer also provides the remaining credentials. For example, some companies store or hold onto their customers’ public keys, but do not allow for the completion of a transaction without the customer providing a corresponding private key. Thus, there is no ability for these businesses to put customers’ funds in jeopardy, as all transactions require customer authorization.
The amended bill also covers businesses involved in transmitting, issuing, or exchanging virtual currencies. Many of these companies pose little threat to consumers, yet, in order to comply with the regulations of the Enrollment Program, they will be forced to spend valuable resources that would be better used for researching and developing innovative technology. For example, Time Warner would arguably fall into the broad “transmitting” category because its internet service is used to relay transaction related messages between customers on a virtual currency’s peer-to-peer network. Obviously, Time Warner cannot impact a virtual currency transaction, yet it appears to be covered by the amended bill as currently drafted. Likewise, issuers of virtual currency pose no risk to consumers and are not at risk of facilitating money laundering activities if they do not store or hold virtual currency for their customers, yet they are subject to the amended bill.
Finally, requiring all virtual currency exchanges to participate in the Enrollment Program is an unnecessarily overbroad measure. Regulatory oversight of custodial exchange corporations is productive, as it protects consumers when their virtual (and fiat) currency is in the possession of the exchange. However, non-custodial exchanges that solely provide peer-to-peer exchange services, never hold the virtual currency that is traded between consumers. Thus, regulatory oversight will not protect consumers, such that these exchanges should not be the subject of the Enrollment Program.
California’s move towards a five-year Enrollment Program, as opposed to a licensing scheme, signals a realization of the developing nature of virtual currency businesses and the State’s need to let businesses operate and innovate in California while regulators develop an understanding as to how virtual currency businesses are going to impact finance and commerce. If the legislature revises the final version of the amended bill to reasonably narrow the scope of the bill’s coverage, California will be the first state in the nation to achieve a strong balance between regulation, innovation, and consumer protection with respect to virtual currency.