It seems like a natural progression for a company that provides any sort of payments-related information processing to migrate from handling data about payments to seeking to handle the payments themselves. But it can be a challenge for any company, particularly a younger one, to determine whether a payments-related service it wishes to offer — even if it is only part of a larger suite of services — is subject to regulation as money transmission. This question is important because nearly every state regulates money transmission under its own state-specific licensing framework, and the statutory definitions of money transmission can be construed broadly to cover any entity that “receives” or “transfers” money.
With respect to integrated data and payment processing services, a general focus of both industry and regulators has been whether “agent of a payee” transactions relating to bill payments and merchant payment processing constitute money transmission subject to state and federal regulation, or are potentially exempt from licensing/registration under certain circumstances.
And, gaining prominence of late is the more specific question of how money transmission laws apply to companies that provide payroll processing services, including receiving payroll funds from employers and delivering those payroll funds to employees, and receiving payroll taxes from employers and delivering the taxes to state and federal taxing authorities. The issue has taken on new significance because of last month’s widely reported failure of a New York–based payroll company, MyPayrollHR. According to news reports, the company allegedly diverted $35 million of payroll funds due to the employees of the company’s employer-clients.
The governor of New York swiftly called for an investigation of MyPayrollHR by the Department of Financial Services (DFS), which regulates New York money transmitters, among other types of financial services providers. Recent reports indicate that the DFS has sent subpoenas “to more than 40 payroll processors that do business in” New York State. The DFS does not appear to have asserted that payroll processors are engaged in activity subject to regulation under the money transmission laws, but it is possible that the investigation of New York payroll companies, combined with scrutiny of MyPayrollHR, could lead to a re-evaluation of the status of payroll processors.
To date, state approaches to payroll processing have been inconsistent. A small number of states, including California and Washington, provide statutory exemptions from money transmission licensing and regulation for companies that engage in payroll processing activities (including the receipt and transmission of wages), provided certain criteria are met. See Cal. Fin. Code § 2010(j); Wash. Rev. Stat. § 19.230.020(15). On the other hand, a few states, such as Connecticut and Texas, have indicated that they believe payroll processing companies that receive employer funds and transmit those funds to employees may be subject to money transmission licensing in their states. For example, in stating a no-action position in 2017 regarding the applicability of the Connecticut money transmission law to payee agents, the Connecticut Department of Banking reiterated its position that payroll solutions providers would be required to obtain a money transmission license. The Department reasoned that, “inasmuch as funds are being held in a payroll processor’s account before being sent to the intended payees,” such activities “would constitute engaging in the business of money transmission.” In the same memo, the Department of Banking also affirmed its position that “there was no exception to Connecticut’s money transmission licensure requirement simply because the money transmission was incidental to the payroll management business.”
Most states have not expressly addressed whether their money transmission licensing laws apply to payroll processing. However, the MyPayrollHR events have focused the attention of the New York DFS on the payroll processing industry, and that focus may encourage additional state banking departments to take up the issue as well. In this regard, the Conference of State Bank Supervisors, which is currently working with state banking departments to “modernize state regulation of non-banks,” has just released proposed model language for state money transmission laws, along with commentary on its proposed approaches. This proposal specifically notes the MyPayrollHR incident in a discussion of whether payroll processing activities should be excluded from money transmission licensing regimes.
In light of these developments, companies that engage in payroll processing activities should consider the potential implications of a regulatory shift in the perception of payroll processing activities and the broader application of state money transmission licensing laws to payroll services.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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