MEMORANDUM

To: Cyberpayments Working Group of the Uniform Money Services Business Act Drafting Committee

From: Anita Ramasastry

Re: Issues to be considered by the Working Group

Date: January 5, 2000

____________________________________________________________

The questions that the cyberpayments task force may want to consider include:

1. What (if any) new payment mechanisms might be included within the scope of the UMSBA? Included in this are stored-value cards, electronic currency, and on-line bill payment services. Subsidiary questions include whether any of these new payment mechanisms pose safety and soundness concerns or money laundering concerns when non-bank issuers/sellers are involved?
2. Should the current definition of stored-value instrument be amended
3. To the extent that Internet-based payment mechanisms (e.g., on-line bill payment services) are included within the definition of a money-services business, what jurisdictional concerns arise and how should the UMSBA deal with such problems? (e.g. creating a possible home licensing state for licensing purposes)

As part of this analysis, the Working Group may need to consider the following types of materials and information:

1. Current state amendments to or interpretation of existing money transmission statutes to include stored-value/electronic payment instruments.
2. Secondary material which explains the way in which different types of payment merchanisms and cases addressing approaches to jurisdiction on the Internet.

1. Types of Payment Mechanisms to be considered by the Working Group

Stored-value products are a recent innovation in payment systems technology. Stored-value products possess certain basic characteristics. According to the Federal Reserve, stored-value products share three attributes: "(i) [a] card or other device electronically stores or provides access to a specified amount of funds selected by the holder of the device and available for making payments to others; (ii) the device is the only means of routine access to the funds; and (iii) the issuer does not record the funds associated with the device as an account in the name of (or credited to) the holder."

Stored-value cards are also known as "smart" cards, prepaid cards, or value-added cards. These cards maintain on a computer chip a stored-value of funds available to be used by a person for various types of retail transactions. A balance is recorded on the card which is debited at a point-of-sale terminal when a consumer or individual makes a purchase. Typically, a consumer will pay a bank or other provider money in exchange for a card that is loaded with value. The consumer uses the card rather than paper currency to purchase good and services. Merchants who accept smart cards can transfer the value of accumulated credits to their bank accounts. A smart card is not typically used for transactions over the Internet. Several new services, however, provide for remote payments to be made by electronic currency that is stored on the hard drive of a person's computer.

When discussing stored-value, commentators refer to "closed" and "open" systems. A closed system is one where the stored-value card can be used only for goods and services provided directly by the card issuer. For example, a university may issue a stored-value card which students may use to purchase books, cafeteria food, and fares on the university's bus system. An "open" system is one where the issuer is not the provider of goods and services but is perhaps part of a group of issuers whose stored-value cards are accepted as a form of payment by a host of merchants.

Several States have begun to include stored-value within their existing money transmission law. Connecticut, for example, has defined stored-value as a form of "electronic payment instrument." This term would also include electronic traveler's checks. Other States, such as Texas, have included stored-value providers by interpretation. West Virginia defines "currency transmission" or "money transmission" to include "the transmission of funds through the issuance and sale of stored-value cards which are intended for general acceptance and use in commercial or consumer transactions."

The Texas Banking Department has explained, for example, its rationale for requiring nonbank issuers of open system stored-value cards to obtain a license under the Texas Sale of Checks Act:

Oregon is the most recent state to include a provision for the regulation of stored-value. Section 2 of the Sale of Checks Act includes a definition of electronic instrument which "means a card or other tangible object for the storage of information, that is pretended and for which the value is decrement upon each use." The term excludes "a card or other tangible object that is redeemable by the issuer in the issuer’s goods and services."

At the October 1998 meeting, the Drafting Committee affirmed its decision to include stored-value products and stored-value providers within the scope of the Act. Drafting Committee members saw the use of stored-value as a means of payment as similar to money transmission. Therefore, to the extent possible, the Drafting Committee recommended including stored-value within existing definitions of payment instruments. The Committee has made the following decisions with respect to stored-value:

• stored-value is defined as a form of electronic payment instrument and thus the sale of a stored-value instrument constitutes the sale of a payment instrument for purposes of UMSBA;
• non-bank issuers of stored-value have been exempted from the licensing requirements of the UMSBA if they are subjects by a federal or state-banking regulator to a safety and soundness regime that addresses investment and capital requirements.
• stored-value issuers, sellers and redeemers are treated as payment instrument sellers; payment instrument sellers, in turn, are subsumed under the definition of money transmitters, thereby triggering the Article 2 licensing provisions of the UMSBA;
• closed-end stored-value instruments such as phone cards or metro cards are not included within the definition of stored-value instrument; and
• stored-value issuers that are subject to supervision and oversight by a federal or state banking agency are also exempt from the licensing provisions of the Act.

The Working Group should examine the existing definition of stored-value and stored-value instrument to determine whether they are appropriately drafted. Some observers have noted that the term "stored-value instrument" focuses on the use of the card rather than on the concept of the "value" itself. Additionally, the Drafting Committee has raised concerns about the criteria used for exempting certain non-bank issuers of stored-value, from licensing and regulation under the UMSBA.

New types of cyberpayments or Internet payment mechanisms have been referred to by regulators and commentators by a host of different names including electronic cash, digital cash, electronic currency, and internet or on-line scrip ("E-money") E-money refers to money or a money equivalent that is transformed into information stored on a computer ship or a personal computer so that it can be transferred over information systems such as the Internet. Technology permits the transmission of electronic value over networks that link personal computers (PCs) and the storage of electronic cash on the hard drives of personal computers.

One of the main issues that the cyberpayments Working Group needs to consider is whether a payment service provider is actually holding funds received from consumers for its own account and has redemption obligations to consumers. To the extent that a service provider has outstanding obligations to consumers (that might not be honored in the event of the entity’s insolvency), safety and soundness issues may arise.

There are two primary methods by which a consumer can make payments over the Internet. The first type is through use of a traditional payment method such as ACH or credit card. The Internet serves as a mode of communication only.

The second type of Internet payment mechanisms involve "E-Money". One type of Internet-based E-money system has been described as a token or notational system. These computer-based systems involve a customer purchasing electronic tokens, which serve as cash substitutes for transactions over the Internet. With this type of system, "money" or "value" is purchased from an issuer (who may be bank or a nonbank). The value is then stored in a digital form on a consumer's personal computer and the notational value is transferred over the Internet. The "coin" is merely a notational series of numbers or other symbols that are transmitted over the Internet to a merchant. The merchant must then redeem the "coin" with an issuer – who will verify that the coin has not been spent previously.. The issuer of the Internet E-Money or "scrip" is obligated to redeem these payments when received from the merchant.

Commentators have noted that state money transmission statutes may, by implication, include or regulate Internet payment systems such as the notational systems described above. Others have suggested that in the future might be a source of prudential regulation for non-bank entities engaged in this activity. For example, The United States Consumer Electronic Payments Task Force has noted:

Token or notational systems may involve exchange of value that is not redeemable in money. For example, the term "scrip" has been used to refer to value that may be exchanged over the Internet but which may not be redeemable for money. Scrip is more analogous to coupons or bonus points that can be exchanged by a consumer for goods or services but have no cash redemption value. Scrip can be used by merchants to sell access to value-added Web pages on a per-access basis or a subscription basis. They can also use scrip to provide promotional incentives to users. Scrip can represent any form of currency, points in a frequent user program, access rights, etc.

In addition to token or notational systems, there are also "account-based" E-money systems. Account-based systems involve a consumer purchasing "E-money" by debiting an existing bank account or using a credit card to buy "coins". The Internet is a place where the value may be stored and then used for transactions. The merchant who accepts the E-money ultimately redeems the account-based E-money with a bank or credit card company.

Banks and nonbank have begun to offer Internet bill paying services. For a fee, electronic bill payment services pay certain bills for consumers, after receiving authorization from a consumer. The customer accesses the service via the Internet. Bill payments may subsequently be made for the consumer electronically. Typically, the service provider will use an Automated Clearinghouse (ACH) transfer to effectuate payment. However, if the designated payee does not accept electronic payment, the bill-paying service will print and mail a check on behalf of its customer. When a nonbank service is involved, the nonbank has no contractual relationship with the consumer's bank. Instead, the consumer’s bank will transfer money to the bill-paying service company. The bill-paying service will, in turn, deposit the funds into its own bank account. The bill-paying service will then issue a payment instrument payable on its own account to the designated payee.

The Texas Department of Banking has required at least one bill-paying service, CheckFree, to obtain a license under its Sale of Checks Act. Texas made this decision based on the fact that the bill-paying service was holding the money of consumers in its own account and issuing payment instruments to merchants payable on the same account. The Texas Sale of Checks Act defines a check to include "an instrument for the transmission or payment of money, including a draft, traveler's check, or money order. The term also includes an instrument for the transmission or payment of money in which the purchaser or remitter of the instrument appoints or purports to appoint the seller as its agent for the receipt, transmission, or handling of money, regardless of who signs the instrument." Texas is currently assessing the situation with several other Internet bill-paying services. California may also have required an Internet bill-paying service to obtain a license under its relevant statute. By implication, bill payment services may already be included within various sale of instruments or money transmission statutes.

The issue of Internet jurisdiction is an areas where there has been increasing litigation and commentary. In the United States, for determining whether personal jurisdiction can be exercised over a defendant whose only contact with the state is through the internet, courts have evaluated the nature of the internet web site and the quality of the commercial activity conducted. ^.. Where a defendant clearly is doing business by entering into business contracts that involve repeated and knowing transmission of data over the internet, personal jurisdiction is proper. Where a defendant’s web site merely advertises the defendant’s product, personal jurisdiction usually is inappropriate. Where the defendant’s web site allows a user to exchange information with another computer, jurisdiction is determined by the level of interactivity and by the commercial nature of the information exchanged.

Courts, when determining whether jurisdiction is appropriate, look to the nature and quality of the commercial activity that a defendant conducts over the internet The Western District of Texas, in an internet gambling case, stated the sliding scale discussed in Zippo that courts have used is consistent with personal jurisdiction principles. The court described the sliding scale as:

In Thompson, the court held that jurisdiction was appropriate since the defendant had continually interacted with casino players, entering into contracts with them to play the various games and knowing full well that he would receive commercial gain through these contracts. Moreover, those who played the casino games did so as if the games were physically located in Texas, and if a party should win, the defendant would send the winnings to that person in Texas.

Courts have also looked to the intent to attract users to employ their services, which then leads to bilateral contacts. The Court of Appeals in Minnesota affirmed jurisdiction over a defendant who had advertised a forthcoming on-line gambling service and had compiled a mailing list that included Minnesota residents. N.W.2d 715, 717 (Minn. Ct. App. 1997), aff’d The court reasoned that internet advertisements are similar to direct mail solicitation in that advertisers distribute messages to internet users; users must take affirmative steps to receive the advertised product. The contacts, thus, are not unilateral. Here the web site indicated the company’s intent to seek customers from a broad geographic area that included Minnesota by stating that it was "open to International markets." . The court then employed a five factor test to determine the constitutional validity of the state exercising personal jurisdiction: quantity of contacts, nature and quality of contacts, relatedness between the contacts and the cause of action, interest of the state, and convenience of the parties. Since the defendant had a clear intent to solicit business from internet users in Minnesota and 248 contacts in a two week period were registered, including at least one successful solicitation, and since the cause of action arose out of these contacts and the state had an interest in regulating gambling, jurisdiction was appropriate.

Steven Betensky’s article/speech, Jurisdiction and the Internet, 19 Pace L. Rev. 1 (1998), reviews how courts have approached exercising jurisdiction and the internet. He describes three approaches to jurisdiction and the internet, and these three approaches were highlighted in Zippo Manufacturing Co. The three approaches are: (1) contracts entered into through a web site; (2) cases involving interactive sites; and (3) cases involving passive web sites. Generally speaking, cases involving contracts where there is repeated transmission of information, jurisdiction is proper. Cases involving pass web sites, such as advertisements with noting more, jurisdiction is not appropriate. Cases involving interactive web sites, a web site where information is exchanged, jurisdiction depends on the nature and quality of the contacts.^.

Betensky lists seven factors that have been considered when determining whether jurisdiction is appropriate for interactive web sites: (1) does the site require registering or signing on to the web site; (2) have agreements been entered into through the web site; (3) is e-mail available; (4) has the site been accessed by users located in the forum; (5) is the site commercial in nature; (6) does the site solicit sales through the site and is there a contract; and finally, (7) is the site primarily local or does it serve a national market. These factors have also been applied for determining whether a site is passive or interactive. The distinction between passive and interactive web sites is not entirely clear as courts have weighted these factors differently^.

Richard Philip Rollo’s casenote, The Morass of Internet Personal Jurisdiction: It is Time for a Paradigm Shift, 51 Fla. L. Rev. 667 (1999), discusses internet jurisdiction in relation to the Supreme Court’s approach to personal jurisdiction: i.e., stream of commerce or stream of commerce plus. The note refers to Humphrey v. Granite Gate Resorts, 568 N.W.2d 715, 717 (Minn. Ct. App. 1997), aff’d 576 N.W.2d 747 (Minn. 1998) (internet gambling) and Zippo Manufacturing Co., supra.

Stomp, Inc. v. Neato, LLC, 61 F.Supp.2d 1974 (C.D. Cal. 1999), a patent infringement case, likewise refers to Zippo’s continuum and finds that the commercial nature of the web site supports establishing jurisdiction over the defendant. Id., at 1078. The use of the web site placed products into the stream of commerce. Moreover, NeatO intended consumers to purchase its products via the internet. Id. Therefore, by using the internet with the intent to engage in commerce and actually doing so, NeatO established the minimum contacts that are a prereqiste to jurisdiction. Id.

Resuscitation Technologies, Inc. v. Continental Health Care Corp., 1997 WL 148567 (S.D. Ind. 1997) (with reference to Zippo, personal jurisdiction exercised due to the numerous and continuous use of email messages over a period of several months). The court stated: "[t]he quality of those electronic contacts is measured with reference to the intended object of that activity." Id. In this case, the parties communicated via email and regular post, and had face-to-face meetings out of state. All of which were intended to negotiate a commercial agreement to transact business. Since the parties intended to transact business and exchanged several email messages, jurisdiction was appropriate.

http://www.ecashtechnologies.com

http://www.stls.frb.org/fspc/eleccurr.pdf

http://cla.org/Publications/RuhBook/chp8.htm

http://www.gao.gov/AIndexFY97/abstracts/gg97073.htm

http://www.itas.fzk.de/deu/tadn/tadn298/coat298a.htm

http://www.occ.treas.gov/emoney/ceptfpap.htm

http://www.abanet.org/buslaw/efss/home.html

http://www.banking.com/aba/cover_0998.asp

http://www.smu.edu/~jwinn/clashoftitans.htm

http://robotics.stanford.edu/users/ketchpel/ecash.html

B. Jurisdiction Links

http://www.ilpf.org/confer/present99/

http://miser.suffolk.edu/law/hightech/classes/cyberlaw/sjensen/paper.htm

http://www.unc.edu/courses/law357c/cyberprojects/spring98/dewey/cyber.html

http://www.uottawa.ca/~geist/jurisdiction.html

http://www.jmls.edu/cyber/index/juris.html