In March 2021, PayServices, Inc., a registered money services business, sought to charter a new Florida state bank. PayServices also applied to the FDIC for deposit insurance, but withdrew its application a few weeks later. In December 2021 PayServices tried again with a deposit insurance application, but again withdrew its application a short while later in January 2022. PayServices filed for deposit insurance once more on March 16, 2022, but withdrew less than a week later on March 22, 2022.
At S&P Global Market Intelligence, Alex Graf wrote about what in the company’s view was causing the trouble.
Regarding PayServices' repeated applications to the FDIC, COO Ron Raitan described the problem as "trying to fit a square peg into a round hole," as the company's nontraditional business model is clashing with the regulator's perception of how a bank should operate. In particular, PayServices executives said the company's status as an institution that does not issue loans is posing a major hurdle in its efforts to obtain approval from a regulatory body that largely functions to insure banks that take deposits and make loans.
"The FDIC, quite frankly, is an insurance company and we don't meet their particular requirement for insurance," said Raitan. "We are trying to mold to the requirements of the FDIC even though we don't fit into that model."
Additionally, the executives said the FDIC's lack of specificity in its feedback contributed to the company's decision to withdraw and reapply, but that they are addressing the regulator's feedback as thoroughly as possible and feel confident they will ultimately gain approval.
The article closed with a quote from the company’s founder:
"We are confident that, at the end of the day, at some point we are going to be in the market," [Lionel] Danenberg said. "It's just a matter of time."
Shifting Focus to Idaho
Shortly thereafter, PayServices shifted strategic gears and sought to reincorporate in Idaho as an Idaho-chartered banking corporation.1
According to PayServices, the Idaho Department of Finance was impressed, telling PayServices in late July 2022 that the company’s “entire application, procedures and risk management framework was the most sophisticated they had seen to date.” The Department granted preliminary approval to PayServices a few days later on August 3, 2022.2
PayServices alleges that federal regulators were also comfortable with its plans, at least initially. The company says that in April 2022 staff from the Federal Reserve Bank of San Francisco represented to PayServices that “bank failure at PayServices is not possible,” that the company’s business model was “no different than an ATM card” and thus had little operational risk, and that “the FRBSF would be in a position to approve the request for a Master Account based on the business plan and business model that PayServices presented.”
Per the Federal Reserve’s master account application database, PayServices duly applied for a master account on August 8, 2022. After providing additional requested materials around a week or so later, PayServices says the application process went quiet, with follow ups generally met with terse responses from the FRBSF that its review was ongoing.
Frustrated with what it saw as the “excessive” delay, PayServices in May 2023 called in some political firepower.
On May 17, 2023, one of PayServices’ founders, a resident of Florida, requested the formal assistance of the office of U.S. Senator Marco Rubio (R-FL) in obtaining information regarding the excessive 9.5 months delay in processing the request.
On May 18, 2023, Senator Rubio’s office reached out to the Federal Reserve Board asking for the FRBSF to act on PayServices’ approval request.
This apparently unstuck things — an FRBSF official reached out to PayServices the same day saying they were just “wrapping everything up” — but not in the way PayServices hoped. Two weeks later on May 31, 2023:3
[An FRBSF official] issued a one-page letter to PayServices [4 ]to notify them that due to its line of business which focuses almost exclusively on facilitating the trade of commodities through import and export of products from and to the United States, that it was unable to grant PayServices’ request because this line of business is a “novel business model” that is “unproven” and thus presents an “undue risk” to the Reserve Bank.
After receiving this rejection, PayServices in June 2023 sued the Federal Reserve Bank of San Francisco in federal court in Idaho, saying that the FRBSF was required by statute to grant PayServices a master account and that its refusal to do so therefore violated federal law.
The company’s framing of this argument was perhaps a little over the top, comparing the Federal Reserve System’s master account guidelines to redlining.
In the denial of PayServices’ request for a master account approval, FRBSF relied upon the guidelines that it adopted from the Federal Reserve Board.
Those guidelines have not been approved by Congress.
The guidelines adopted by the FRBSF are identical to discriminatory redlining maps that categorize areas based on color. Instead of colors, the FRBSF makes use of “tiers”. Where redlining maps have 3 colors: blue, yellow and red; the FRBSF has 3 tiers: Tier 1, Tier 2, and Tier 3.
FRBSF, by qualifying PayServices has a Tier 3 financial institution, has discriminated against PayServices by putting it in the basket of those that are not desirable because PayServices do not conform to the criteria of preference of the FRBSF; but the law is clear: there is no room for emotions or preferences. The law must be equal to all and applied equally to all. Congress created one law – the Federal Reserve Act – and that is the only law of the land that regulates the FRBSF.
FRBSF Responds
Yesterday evening the FRBSF, through its counsel at Simpson Thacher and Holland and Hart, filed a motion to dismiss the PayServices complaint, with a preliminary statement beginning as follows.
Plaintiff PayServices Bank (“PayServices”) is an online bank that operates no physical branches, does not carry FDIC insurance, and is not subject to prudential supervision by any federal banking agency. Its business model focuses on providing payment processing to foreign merchants, buyers and governments. This litigation concerns PayServices’ request for a “master account”—a depository account that provides institutions with direct access to the Federal Reserve System.
FRBSF has discretion to grant institutions with direct access to the Federal Reserve System through a master account. After nine months of careful review, FRBSF denied PayServices’ request because, consistent with guidelines established by the Board of Governors (the “Board”)—the federal agency in charge of overseeing the Federal Reserve System—FRBSF determined that PayServices’ business model and inadequate risk management controls opened up FRBSF and the Federal Reserve System, as a whole, to risk of illicit financial activity, including terrorism funding.
The motion to dismiss then goes on to make arguments that will be familiar to those following the arguments made by the Federal Reserve Board and the Federal Reserve Bank of Kansas City in the Custodia litigation in a different federal court over that bank’s asserted right to a master account.
Specifically, the FRBSF argues:
The FRBSF has discretion to deny master accounts, and the provision of the Federal Reserve Act upon which PayServices relies (12 USC 248a), in addition to not requiring the grant of master accounts to applicants, in any event “does not apply to FRBSF.”
The FRBSF is not a federal agency or a branch of government.
The FRBSF’s decision was neither arbitrary nor capricious, but instead was based on the master account guidelines — and “PayServices does not plead facts showing that FRBSF’s decision was inconsistent with the Guidelines.”
PayServices received all procedural protections required by law, including the opportunity meet with the FRBSF and to submit written evidence, and thus cannot bring a due process claim.
In its discussion of the first point, the FRBSF includes a footnote acknowledging that “the District Court for the District of Wyoming recently denied a motion to dismiss a complaint alleging the improper denial of a master account.”
However, Custodia did not hold that Section 248a applied to Reserve Banks as a matter of law. Instead, the decision was “based mostly” on one opinion in a three-way split decision of the Tenth Circuit, id. at 10-12 (citing Fourth Corner Credit Union v. Fed. Rsrv. Bank of Kansas City, 861 F.3d 1052, 1053-54 (10th Cir. 2017)), which the Custodia court found “may plausibly be the law on this matter in this case” at the motion to dismiss stage. Id. at 10. The Court expressly deferred on questions of statutory interpretation. Id.
The FRBSF’s motion to dismiss also embraces the argument made by the government in the Custodia case that last year’s NDAA serves as evidence of Congress’s belief that the government has the discretion to reject master account applications.
Further, Congress recently confirmed that Reserve Banks can deny requests for master accounts. In December 2022, Congress amended the FRA to require the Board to “create and maintain a public, online, and searchable database” that includes “a list of every entity that submits an access request for a reserve bank master account and services . . . including whether . . . a request was approved, rejected, pending, or withdrawn.” […]
Thus, by its plain terms, Congress specifically contemplated that requests for master accounts from uninsured depository institutions (such as PayServices here) may be “rejected.” It strains credulity to assume that Congress mandated the Federal Reserve System to track all rejected applications for master accounts if the Reserve Banks had no discretion to reject master accounts in the first place.
When it was made in the Custodia case, this argument led former Senator Toomey to file an amicus brief arguing that the Federal Reserve had “miscontrue[d]” the amendment. Ultimately the Custodia court was also not convinced by the government’s reading, saying that:
[A]t the time Congress passed § 248c it was known that Federal Reserve Banks had “rejected” master account applications in the past, but § 248c cannot be read as Congress’ imprimatur on Federal Reserve Banks holding carte blanche to grant or deny master account applications… Section 248c does not, expressly or impliedly, carry the statutory construction load the Board of Governors asserts it does.
It is not clear whether this argument or others made by the FRBSF will prove more successful at the motion to dismiss stage here.
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The facts, assertions and quotations in this sentence and the following paragraphs come from a complaint filed in federal court by PayServices. A court is generally required at the initial stage of litigation to take PayServices’s factual allegations as true. This blog is less bound by such constraints but still will try its best to just present the facts as pled, resisting too much editorial commentary.
See also bank.payservices.com (“PayServices received a provisional approval from the State of Idaho to reincorporate as a banking corporation. The bank is currently in organization and not presently opening accounts.”).
It is not clear what conclusions, if any, should be drawn from this, but processing of the PayServices application (filed August 2022; rejected May 2023) moved much more quickly than the processing of some of the other controversial master account applications that have been rejected or are still pending:
Commercium Financial - filed May 2022, still pending as of May 31, 2023
Custodia Bank - filed October 2020, rejected January 2023
Kraken Financial - filed October 2020, still pending as of May 31, 2023
Banking Circle - filed November 2019, still pending as of May 31, 2023
TNB USA Inc. - filed August 2017, still pending as of May 31, 2023
A full copy of this letter is included as an exhibit to the government’s response. It has been extracted as a separate PDF here.
Incidentally, thanks to the reader who emailed a few weeks ago to point out that many PACER filings are available for free and publicly accessible to all via CourtListener. If you are reading this from a computer than cannot access Google docs, the motion to dismiss should be publicly available shortly via the CourtListener docket page for this case.
