Banking Interpretations

June 3, 2002

John D. Muller, Esq.
General Counsel and Secretary
PayPal, Inc.
1840 Embarcadero Road
Palo Alto, CA 94303

Re: Opinion regarding PayPal activities.

Dear Mr. Muller:

Your March 7, 2002 letter to Barbara Kent, Director, Consumer Affairs and Financial Products, New York State Banking Department ("Department"), that provides a supplemental analysis regarding the applicability of New York Banking Law to funds received by PayPal, Inc.[1] ("PayPal") on behalf of New York customers that are held for future use by customers in a PayPal "agency" account and not transferred to the customer's third party bank account or paid to the customer by check, has been forwarded to me for response.

On February 18, 2002, at the request of the Department, a meeting was held at the Department's offices with you and other representatives of PayPal to discuss PayPal's activities with New York customers and to address the concerns previously raised by the Department regarding those services offered to New York customers.  Prior to that meeting, Steven Barras, Assistant Counsel, authored two (2) letters in response to inquiries by PayPal's former outside counsel indicating that certain of PayPal's services constituted illegal banking activity and that those services should not be provided to New York customers.

In his July 18, 2000 letter, Mr. Barras stated that the Department interposed no objection to PayPal offering certain of its payment processing services to New York customers without being licensed as a money transmitter pursuant to Article XIII-B of the Banking Law.  However, Mr. Barras also stated that PayPal's practice of retaining money on account for New York consumers for future use constitutes illegal banking, and, consequently, that option should not be offered to New York customers.  The Department's position was reaffirmed by Mr. Barras in his January 10, 2001 response letter.

During the February 18, 2002 meeting, PayPal explained to the Department that subsequent to Mr. Barras' January 10, 2001 letter, significant changes had been made to its business model with respect to customer monies being held on account.  During the meeting, PayPal expressed its belief that these changes should resolve the Department's remaining concerns and, at the conclusion of the meeting, PayPal agreed to provide the Department with the supplemental analysis provided by your March 7, 2002 letter.

According to PayPal, its business model now offers a customer five (5) options with respect to the payment and receipt of monies through PayPal's service.[2]  Additionally, funds are distributed in accordance with the PayPal User Agreement that creates a contractual relationship between PayPal and its customers. 

Under the first method of disbursement, funds are placed into an account at a bank that the PayPal customer can access by either a physical or virtual debit card.  The second option is a wire transfer by Wells Fargo Bank, on behalf of PayPal, to the bank account at a third party bank in the name of the PayPal customer.  The third option is that a check payable to the PayPal customer selling goods or services is processed by Wells Fargo Bank and forwarded to that customer.  As stated in Mr. Barras' letters, the Department raised no objection to these three (3) methods of payment concluding that although these activities constitute money transmission, PayPal was not required to obtain a money transmission license since it did not have a physical presence in New York, either directly or through agents.  

When a PayPal customer does not direct PayPal to immediately disburse said funds, PayPal provides two options: (a) sweeping funds to purchase shares in the customer's name in the PayPal Money Market Fund ("Money Market Account"); or (b) pooling funds with other customer funds and placing them in a bank account denominated, "PayPal, Inc., as agent for the benefit of its customers" at one or more FDIC-insured banks ("FBO Account").[3]

According to PayPal, the Money Market sponsor is an independent entity not affiliated with PayPal.  The Money Market is subject to regulation by the Securities and Exchange Commission ("SEC") and is operated in accordance with the SEC's supervisory guidelines for such entities.  Since the Money Market is managed by a separate entity, the funds in the Money Market are not carried on PayPal's balance sheet.

PayPal's user agreement states that PayPal is only the customer's agent with respect to funds in the FBO Account.  Since it is only an agent, the FDIC has concluded that the funds in the FBO Account are eligible for FDIC pass-through insurance.  The FBO Account is a non-interest bearing bank account from which PayPal derives no economic benefit and the funds again are not carried on PayPal's balance sheet.[4]

On January 18, 2002, PayPal's former counsel forwarded to Mr. Barras a copy of a request by PayPal for an advisory opinion from the Federal Deposit Insurance Corporation ("FDIC") regarding the deposit insurance issues raised by the operations of PayPal and a copy of the legal opinion from outside counsel addressing the federal bankruptcy law issues raised by PayPal's business model.  Although the FDIC declined to opine as to whether PayPal would be deemed to be accepting deposits in connection with its service, the opinion did state that, assuming PayPal was truly acting as an agent for its customers, then funds placed in the FBO account would be eligible for pass-through deposit insurance coverage.  However, PayPal was later informed by the Department that these two (2) opinions had not changed our previous opinion regarding the deposit issue with respect to these last two (2) options.

Your March 7, 2002 letter provides three points to further support PayPal's contention that its payment processing business does not engage in the prohibited practice of deposit-taking by a non-banking corporation in violation of Section 131 of the Banking Law.

First, PayPal contends that under New York law, the terms and conditions of its User Agreement establishes that a deposit into the Money Market or FBO Account creates a debtor-creditor relationship between the depositor and depository.  PayPal points to the fact that its User Agreement establishes an agency relationship between PayPal and its customers with respect to the FBO Account.  PayPal also cites to the finding in the FDIC opinion letter that the User Agreement, "strongly support[s] the existence of an agency relationship between PayPal and its customers" and the fact that by placing the funds in the non-interest bearing account, PayPal receives no benefit therefrom.

Second, PayPal contends that applicable New York case law distinguishes between acting as an agent in a transaction involving banking services and acting as a bank.  In Independent Bankers Association of New York State, Inc v. Marine Midland Bank, N.A., 583 F. Supp 1042 (W.D.N.Y. 1984), a supermarket was responsible for loading cash into automated teller machines ("ATM") located in the supermarket, and the consumer withdrawals of cash from said ATM's were processed by crediting the supermarket's account at the appropriate bank in the amount of the withdrawal, plus a fee paid to the supermarket by the bank.  The court held that the supermarket was acting as an agent for the bank and not as a banking institution itself since the ATM merely provided a vehicle through which the bank can transact business with its customer.  By analogy, PayPal claims that the payments it receives on behalf of customers result in credits to the FBO Account managed by PayPal and therefore, PayPal, like the supermarket above, is acting as an agent for the customer and not as a banking institution.

Third, PayPal claims that New York case law on Banking Law §131 stands for the proposition that certain powers conferred upon banks under the Banking Law which, in some form, individuals and corporations customarily exercise in their operations, are clearly not banking functions.  In addition to the case law, PayPal states that companies routinely exercise powers conferred upon banks without a bank charter when their core business is payment processing.  In further support, PayPal states that the Money Market feature and the FBO Account are incidental to its core payment processing business and it does not engage in any activity that is the primary concern of bank regulation, such as credit risk, liquidity risk and interest rate risk.  PayPal also claims that there is no need for "bank-level" regulation since its internal controls are sufficient to protect and promote the safety of the customer funds in the Money Market and FBO Account.

Lastly, PayPal's letter addresses the issue of whether Banking Law §131 also applies in the money transmission context to prohibit PayPal from receiving money transmissions without a license or an exemption.  PayPal looks in this regard to Banking Law §641(1) for the exemption based on its argument that a company that acts as an agent for payees is not engaged in money transmission activities and need not obtain a money transmission license.  While it continues to believe that its activities do not require it to obtain a money transmitter license, PayPal offered to file a money transmitter license application with the Department if requested.  Importantly, subsequent to receipt of the March 7, 2002 letter, during a telephone conference with representatives of the Department, counsel for PayPal indicated that while it currently has no physical presence or agents in New York, PayPal fully anticipates having a physical presence in New York in the future.

The issue of whether the payment services offered to New York customers by PayPal, which has no physical presence or agents in New York, are subject to regulation by the Department presents a novel question.  Based upon its review of PayPal's new business model and the relationships created by the User Agreement, which are substantially different from PayPal original business model with respect to the maintenance of customer funds not disbursed upon receipt, the Department concludes that PayPal is not currently engaged in illegal banking.

However, the Department remains concerned that PayPal is offering payment services to New York customers without being subject to supervision by a national or New York regulatory body.  Given that PayPal's business model is relatively new, continues to evolve and will likely go through several more iterations in the near future and PayPal's intention to have a future physical presence in New York, the Department believes the best course for New York customers would be for PayPal submit an application to obtain a New York money transmitter license as soon as practicable.  

Thank you for your attention to the above.  Please do not hesitate to contact me should you wish to further discuss this matter.

Very truly yours,


Alvin A. Narin
Assistant Counsel

[1] PayPal is located in Palo Alto, California and does not have a physical presence or agents in New York.

[2] It should be noted that PayPal receives funds on behalf of customers through two (2) methods: 1) by credit card processed by EPX/First Union or through wire transfer received at Wells Fargo Bank ("Bank").

[3]  If the customer does not select any option, then the funds are directed to the FBO Account.

[4]  In the March 7, 2002 letter, PayPal states that it received confirmation from PriceWaterhouseCoopers, LLP, its independent auditor, that customer funds held in the FBO Account should not appear on PayPal's balance sheet.