Source: https://www.eblawyers.com/category/blog/
Timestamp: 2019-04-23 22:45:43+00:00

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HOW TO PLAY IN ARIZONA’S FINTECH SANDBOX – PART V: How to Comply.
The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which started accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. This is the last of a five part series on how to apply and participate in the sandbox. If you are new to the series, go back and read the first four parts, which discuss the history of sandbox programs, the benefits of participation in the Arizona sandbox, eligibility requirements, and the application process. This part five will explain the rules you will be subject to once in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
Operating restrictions: Sandbox participants are only permitted to test their innovation for a period of 24 months, and only on 10,000 Arizona consumers. If the participant demonstrates “adequate financial capitalization, risk management process and management oversight,” then the AG’s office may agree to expand the size of the participant’s test market to 17,500 consumers. Consumer lenders are permitted to issue consumer loans up to $15,000 (except loans to a single consumer may not exceed $50,000), and money transmitters may engage in transactions up to $2,500 (aggregate of $25,000). Money transmitters that satisfy the capitalization and management requirements to increase the market size to 17,500 may also be eligible to increase their transaction limits to $15,000 (aggregate of $50,000).
Statutory Compliance: As was discussed at greater length in part two, the primary benefit of the sandbox is exemption from all state licensing and regulatory obligations except for the ones specifically identified by the sandbox program. I will not attempt to itemize the specific statutory requirements that continue to apply in the sandbox or their implications for each industry, but suffice to say, participants must take special care that they do not violate the rules they are still subject to. Critically, the sandbox does not exempt participants from federal statutes and regulations.
Document retention and reporting requirements: The recordkeeping requirements normally applicable to companies in the financial sector are replaced by the sandbox’s simpler requirement: participants must retain records, documents and data produced in the ordinary course of business. The sandbox does not currently have a period reporting requirement, but sandbox participants must be ready to disclose records, documents, and data to the AZ AG upon request at any time. The AZ AG will also have the authority to establish a periodic reporting requirement in the future as it sees fit. These records will be used by the AG’s office in connection with their oversight role, and will not be considered public records generally available to the public. However, the records may be disclosed to other state, federal, and even foreign authorities.
Consumer Protection: Sandbox participants will still be required to take certain steps to ensure that their products and services do not harm consumers. For example, if the innovation fails before the end of the testing period, participants are obligated to promptly notify the AG’s office and report on the steps it took to protect its consumers. If the participant becomes aware of a data breach compromising sensitive data, the participant is still subject to the requirements of A.R.S. § 18-545, which requires prompt notice to affected consumers.
Finally, before providing a product or service, participants will need to make a clear and conspicuous disclosure in English and Spanish, and for online transactions the consumer must acknowledge receipt. The disclosure must include five statements: (1) the name, registration number, and contact information for the participant, (2) that the participant does not have an Arizona license but is authorized under the sandbox program, (3) that the state of Arizona does not endorse the innovation, (4) that the product is in a test phase that may terminate upon a specified date, and (5) that consumers can contact the Arizona AG’s office to complain.
Don’t Be A Fraudster: All sandbox participants are still subject to the Arizona Consumer Fraud statute (A.R.S. § 44-1521 et seq.), which generally prohibits false, deceptive, or misleading statements in connection with an advertisement or sale. Violators are subject to civil penalties and may get booted from the program. Unsurprisingly, participants will also get booted from the program for violation of state or federal criminal laws.
Arizona’s fintech sandbox program is a tremendous opportunity for startups as well as established financial services companies that are developing new innovative products. Not only does it provide a safe and less costly way to test your innovation in the marketplace prior to a full launch, but it also puts you in a good position to immediately take advantage of any similar sandbox program launched by the CFPB in the coming years.
About the Author: Michael Rolland is a member of the civil litigation and commercial transactions practice groups with the law firm of Engelman Berger, P.C. Michael has a special interest in the intersection of technology and the law, and writes on tech law issues.
In Ruffino v. Lokosky, No. 1 CA-CV 17-0353, 2018 WL 3384998 (Ariz. Ct. App. July 12, 2018), the Arizona Court of Appeals held that, under some circumstances, alternative service by email, or even social media, may be a more appropriate means of providing notice of a lawsuit than service by publication.
Judge Paul J. McMurdie delivered the opinion of the Court, in which Presiding Judge Diane M. Johnsen and Judge David D. Weinzweig joined.
Ruffino filed suit against Lokosky for defamation and other related torts for a series of statements by Lokosky on her website. After several failed attempts to serve Lokosky at three addresses identified through skip tracing, Ruffino proceeded with service by publication. Lokosky failed to appear, and the superior court entered a default judgment awarding Ruffino $264,062.50 in damages and injunctive relief. The default judgment was later amended to permit Ruffino to take control of Lokosky’s website, and it was at this point that Lokosky first appeared in the action. Lokosky sought a temporary restraining order and also asked the court to set aside or vacate the default judgment under Arizona Rules of Civil Procedure (“Rule”) 55(c) and 60(b).
After an evidentiary hearing on the issue of service, the superior court made a factual finding that “Ruffino could have communicated with Lokosky about service through several online channels,” which the court later clarified included Lokosky’s email address, phone number, and social media that Ruffino had previously used to communicate with her. Id. at ¶ 6.
The court held that Ruffino had failed to satisfy the requirement of Rule 4.1(l)(1)(A)(i) that he make “reasonably diligent efforts” to ascertain Lokosky’s current address prior to effecting service by publication, because he did not attempt to contact the defendant via available online channels. Id. at ¶ 14 (“A reasonably diligent effort by Ruffino would have included reaching out to Lokosky via telephone, email, or even social media to verify her correct address.”).
The court further held that, even if the plaintiff had made such reasonably diligent efforts, service by publication would still not be available because under the circumstances it was not the best means practicable to provide notice, as required by Rule 4.1(l)(1)(B). The court stated that “[g]iven our present society, we agree with the superior court that modern methods of communication, especially email, were more likely to give Lokosky notice of a suit than publication in a newspaper distributed in a rural area 70 miles from Lokosky’s Scottsdale home.” Id. at ¶ 16 (emphasis added).
Civil litigators should all sit up and take notice of the court’s opinion in Ruffino. In most civil disputes between parties that already know each other—which includes the vast majority of business disputes—the parties will have already communicated by email, phone number, or social media. Ruffino effectively eliminates the availability of service by publication in these cases. However, Ruffino also sends a strong message to lower courts that service by email, and even social media, should be taken seriously as viable methods of satisfying due process. In theory, our courts have always had the procedural authority under Rule 4.1(k) to approve these methods of service (and Rule 5(c)(2)(D) contemplates service after appearance by electronic means), but there has never been clear precedent from our court of appeals blessing these methods as not only valid, but also superior to service by publication.
Going forward, if the current address of the defendant is not known and cannot be discovered through conventional means, litigators should always ask their clients whether they are able to contact the defendant via email or social media. If so, use those channels to ask the defendant for a current address and, if possible, to send a copy of the service package. Be sure to document your efforts. If the defendant does not cooperatively provide you with a current address, Ruffino provides a strong basis to move for alternative service using the online channel available to you.
This is a sensible and very welcome decision by the court. Despite historical acceptance of service by publication, the idea that publication of a summons in the back pages of some obscure physical newspaper is an effective way to give notice in our modern age borders on absurdity.
Every business strives to avoid a trip to court house, but at times litigation cannot be avoided. Businesses (and individuals) are wise to have legal counsel already in place before litigation ensues. Having an established relationship with legal counsel before facing litigation allows your business to be prepared to protect and advance its legal rights from the very beginning of the dispute. One critical reason to have legal counsel in place is to ensure your business understands it obligations to preserve all evidence – both electronic and physical – that is relevant to the potential dispute. In today’s electronic business environment where the great majority of data is created and stored electronically, it is critical that businesses understand their obligations to preserve their electronic data. By properly preserving data, a business can ensure the critical evidence in support of its case can be disclosed during the litigation and ultimately presented to the finder of fact.
The Arizona Rules of Civil Procedure (ARCP) set forth the requirements of all parties to the case to preserve and disclose “electronically stored information” (ESI). Rule 26.1(a)(9) requires all parties to any civil litigation to disclose their relevant ESI to all other parties to the litigation. In layman’s terms, this rule requires a party to preserve and then provide the opposing party with access to all relevant ESI, such as emails, text messages, excel spreadsheets (this is by no means an exhaustive list) that are not protected from disclosure by a privilege (such as the attorney-client privilege). A failure to preserve relevant ESI exposes the offending party to powerful sanctions.
These sanctions for failure to preserve ESI are set forth in Rule 37(g). If ESI is lost because a party failed to take reasonable steps to preserve the data, under Rule 37(g)(2), the Court must then determine whether the party that failed to preserve the information “acted to deprive another party of the information’s use in the litigation.” In other words, the Court must determine if the party intentionally destroyed its ESI to avoid disclosing that ESI to the other parties in the case. If the Court determines a party did act to deprive another party of relevant ESI, the Court may impose sanctions under Rule 37(g)(2)(B) including: (1) presuming the lost ESI was unfavorable to the party that failed to preserve the data; (2) instructing the jury that it must presume the lost ESI was unfavorable to that party; or (3) dismissing the lawsuit (if the Plaintiff destroyed the ESI) or entering a default judgment (if the Defendant that destroyed the ESI). These sanctions will inevitably lead to a poor result in the litigation for the party that failed to preserve its ESI, and likely expose that offending party to an award of attorneys’ fees in favor of the opposition.
Alternatively, if the failure to preserve data was not intentional, Rule 37(g)(2)(A) nevertheless authorizes the Court to make such orders that cure the harm caused by the loss of the ESI. While not as damaging as the sanctions for intentional destruction of ESI, no litigant wants to be in a position where a Court must make an order with the explicit purpose of helping the opposition recover from the inadvertent destruction of ESI.
In order to avoid these potential sanctions for the destruction of ESI, businesses must know when their obligations to preserve ESI begin. Here, Rule 37 again provides guidance. Rule 37(g)(1)(A) states that a party “has a duty to take reasonable steps to preserve ESI relevant to an action once it commences the action, once it learns that it is a party to the action, or once it reasonably anticipates the action’s commencement, whichever occurs first. Rule 37(g)(1)(B)(i-ii) then proceeds to define “reasonable anticipation” to mean when a person “knows or reasonably should know that it will likely be a defendant in a specific action” or “seriously contemplates commencing an action or takes specific steps to do so.” The duties to preserve evidence and the sanctions set forth in Rule 37 for the failure to preserve ESI are consistent with Arizona case law regarding the destruction of physical evidence. See Souza v. Fred Carries Contracts, 191 Ariz. 247, 251, 955 P.2d 3 (App. 1997) (“[L]itigants have a duty to preserve evidence which they know, or reasonably should know is relevant in the action, is reasonably calculated to lead to the discovery of admissible evidence, is reasonably likely to be requested during discovery and/or is the subject of a pending discovery request.”).
Based upon the parameters set forth in Rule 37, a business’s duty to preserve ESI may arise much earlier than its leadership may realize. As an example, a lender has a borrower that defaults on a loan payment. The lender sends a notice of default letter to its borrower reserving all of its rights under the loan documents. Pursuant to Rule 37, the lender’s duty to preserve ESI began at the time the decision was made to send the notice of default. The lender has a duty to preserve all relevant ESI (such as all emails between the borrower and lender representatives). As another example, a company hires a new employee that the company did not know was subject to a non-compete provision from the employee’s previous employer. The previous employer sends the company a letter informing the company that it has hired the employee in violation of a covenant not to compete and threatens legal action. At that point in time, the company (and the previous employer) has a duty to preserve all relevant ESI related to that employee, including email correspondence, on-line employment applications, etc.
Experienced litigation counsel can guide their clients through ESI preservation obligations as well as the production of ESI. Once you have retained counsel, the duty to preserve evidence – in your possession and in your opposition’s possession – is an important issue to discuss. Your legal counsel should provide you, the client, written guidance as to what relevant ESI needs to be preserved. Additionally, your legal counsel may send a “litigation hold” letter to all opposing parties and/or their counsel advising them of their ESI preservation duties under Rules 26.1 and 37. Through a litigation hold letter, your counsel places the opposition on notice of its obligations to preserve all relevant evidence in their possession, including ESI. This will prevent the opposition from later claiming it was unaware of its preservation obligations and insure your ability to obtain critical evidence in the opposition’s possession.
If you have any questions regarding your obligations to preserve evidence for purposes of civil litigation, contact your legal counsel to discuss and work through these issues. These questions should be asked at the beginning of any potential dispute to ensure that all evidence – including ESI – is preserved.
About the Author: Damien Meyer is a shareholder with Engelman Berger and a member of the civil litigation practice group. Damien practices primarily in commercial litigation and business counsel. His focus is to assist businesses and individuals in resolving disputes on a proactive basis to achieve and protect their business objectives and interests.
HOW TO PLAY IN ARIZONA’S FINTECH SANDBOX – PART IV: How to Apply?
The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which started accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. This is the fourth in a five part series on how to apply and participate in the sandbox. If you are new to the series, go back and read the first three parts, which discuss the history of sandbox programs, the benefits of participation in the Arizona sandbox, and eligibility requirements. This part four will explain the application process, and part five will address how to comply with the rules once you are in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
Applying for the sandbox is pretty straightforward: complete a separate application form for each innovation you plan to test, and pay a $500 application fee. The $500 fee will be deposited by the attorney general into the Consumer Protection-Consumer Fraud Revolving Fund, which is a fund used by the attorney general for operating expenses for consumer protection division.
Applications are reviewed by the attorney general’s office on a rolling basis, and decisions will be rendered within ninety days. Under A.R.S. §41-5603(J), the attorney general has absolute discretion to deny an application, and there is no process to appeal the denial. This means that your application better be polished from square one. However, there does not appear to be any restriction on re-applying following a denial, so in theory you can keep submitting new applications (paying a fresh $500 fee each time) until you are admitted.
This section of the application generally requests basic identification and contact information, like the state of incorporation, addresses, federal tax ID, etc., most of which is simple enough for anyone to complete. However, there are a few sections that warrant scrutiny. First, you must designate a contact person for inquiries by the attorney general, and a contact person to handle consumer complaints. These roles can be filled by the same person, and in either case you should take the designation very seriously. Maintaining good standing in the sandbox will probably require quick and careful responses to all complaints and inquiries. These designated contacts will be on the front lines, and will be the first, and sometimes only, person to interact with the attorney general and/or consumers about any problems with your innovation. Make sure the person you appoint has the time to address inquiries quickly, the regulatory knowledge to respond to them accurately, and authority within the company to mandate any necessary internal changes.
any individual or entity, paid or unpaid, that: (i) is primarily responsible for Testing the Product or Service; (ii) has direct supervisory authority over the staff Testing the Product or Service; or (iii) serves as an officer or director of the business or business unit that is Testing the Product or Service.
You must similarly identify “Key Personnel,” who are defined to include Active Managers and any person that owns 15% or more of the company. Before submitting your application, you should ensure that none of your Key Personnel have any black marks on their record. The application specifically requires you to disclose whether any Key Personnel have a felony conviction, have had a civil judgment, order, sentence or even settlement agreement relating to “fraud, money laundering, or a breach of fiduciary duty or trust,” or have been the target of government investigations or regulatory actions relating to financial goods and services. If at all possible, you should take steps to ensure that the people responsible for implementing and overseeing the innovation do not have this type of checkered history. If that is unavoidable, then you should supplement your application with Supporting Documents that demonstrate why the Key Personnel’s history will not undermine the attorney general’s mandate to ensure that consumers are protected.
Third, you must disclose whether you are already licensed to provide a similar service in another state. The attorney general will probably use this information to contact the governing regulatory authority in that state to discover whether you have ever been subject to negative agency action. If you are a larger institution, it is entirely possible you have been the recipient of numerous consumer complaints and/or regulatory censures. We do not yet have any guidance from the attorney general’s office on how they will evaluate this type of history, but I would imagine that they will focus not only on the volume and nature of complaints/censures, but also on how you responded to regulatory issues in the past. Do you respond to complaints quickly? Did you timely comply with all regulatory orders? If this is a concern, you should coordinate with your regulatory department or compliance officer to prepare documentation to explain negative regulatory events.
Fourth, you also need to disclose whether you will be working with, or licensing any technology from, third parties as part of the innovation. These should also be closely scrutinized. Do any of your commercial partners have a history of negative regulatory action or been repeated targets of government investigations? This information will surely be discovered during the attorney general’s review of your application, so be prepared in advance to answer any tough questions that may arise from your choice of commercial partner.
Describe the timeline of the proposed Testing plan and key milestones for the Product or Service given the two-year Testing period and any possible extensions.
What is Your Consumer Protection Plan?
What records and data will You keep in the ordinary course of business?
In this portion of the application you should keep in mind that, underlying all of the specific requests, the attorney general’s office is broadly evaluating whether your innovation offers real benefits to consumers, and whether it is likely to satisfy licensing requirements after completing the sandbox. Therefore, you should tailor your application to clearly demonstrate not only that your testing plan is designed to yield a completed product at the end of the two year testing period, but that you have safeguards in place to protect consumers if things do not proceed according to plan. You should probably also avoid unrealistic projections and overly effusive descriptions of your innovation. Rather, it is better to acknowledge the risks and challenges facing your innovation, because doing so will help demonstrate that you are adequately equipped to address them.
I should also note that your application and any other records submitted to the attorney general will not be considered “public records” generally open to inspection by the public. Therefore, you should feel relatively free to be forthcoming in your application, without fear that some unfavorable piece of information will immediately show up in media headlines. Be aware, however, that these records can be disclosed to state and federal agencies, appropriate agencies of foreign governments, state auditors, and in response to a subpoena.
Getting into the sandbox can be a challenge. You may need to solicit the help of an attorney to ensure your application is completed correctly, particularly if you are a startup or early stage company without experience navigating applicable the regulatory regime. If you do get admitted, then you need to put procedures in place to ensure that you comply with the sandbox’s requirements. More on that will be coming soon in the fifth and final installment of this series.
The Ninth Circuit recently held that a California-based bank with a judgment arising out of a guaranty signed by only one spouse (the husband) of a married couple residing in Arizona could enforce its judgment against the husband’s interest in a co-op apartment in California. While this may seem like a “common sense” result, the holding was surprising in light of what many seasoned Arizona practitioners simply took for granted: that if a husband and wife are domiciled in Arizona, a guaranty signed by only one spouse cannot be enforced against any interest in anything that would constitute community property under Arizona law. The outcome highlights the need for prospective lenders and guarantors alike to understand just how Arizona community property law affects creditors’ rights to enforce guarantees signed by only one spouse—and how the outcome can change when the laws of other states with some connection to the transaction conflict with Arizona law. This series of posts explores those issues. Today’s post covers the basics.
Arizona is a community property state, which means that absent a valid pre- or post-martial agreement, essentially all property and income (except for gifts and inheritances) acquired by a married couple domiciled in Arizona becomes part of a pot of assets known as community property. A.R.S. § 25-211. All other property (e.g., property owned by either spouse prior to marriage) is the separate property of one spouse or the other. A.R.S. § 25-213. Community property can be divided only upon divorce, annulment, legal separation, or death of one of the spouses. If a creditor is barred from collecting its claim from the community, it cannot recover anything from the community property pot. Many spouses who have been married for a long period of time have no separate property; everything they own and all of their income is community property. Thus, if a lender is prohibited from collecting from the community property, it may never be able to collect anything as long as the couple stays married.
Fortunately, the general rule in Arizona is that both spouses have equal power to bind the community to debts. A.R.S. § 25-214(B). Thus, if Big Bank makes a $500,000 loan to Henry Husband and Henry defaults, a judgment for the loan balance would be enforceable against the community property owned by Henry Husband and his spouse Wilma Wife (let’s assume she kept her ironic maiden name for purposes of this example). Big Bank could collect on its judgment by garnishing Henry’s salary, Wilma’s salary, or any other non-exempt property Henry and Wilma acquired after their marriage.
But there are several exceptions to the rule that either spouse may bind the community. One of these exceptions is that “joinder of both spouses is required” to bind the community to “[a]ny transaction of guaranty, indemnity or suretyship.” A.R.S. § 25-214(C)(2). Arizona courts have interpreted this to mean that “the community is not bound by any guaranty that is not signed by both spouses, even though the guaranty was for a business that benefitted the marital community.” Vance-Koepnick v. Koepnick, 197 Ariz. 162, 163, ¶ 5 (App. 1999). While a non-signing spouse can “ratify” a guaranty signed only by their partner after the fact, the evidence of such a ratification must be very clear (such as signing a written ratification agreement), and “cannot be inferred merely from the marital community’s receipt of benefits under that transaction.” All-Way Leasing, Inc. v. Kelly, 182 Ariz. 213, 217 (App. 1994).
So let’s assume that instead of making its $500,000 loan directly to Henry Husband, Big Bank loans $500,000 to his business, Henry’s Hot Dogs, Inc. Henry signs a personal guaranty of Hot Dogs’ debt, but Wilma does not. Several years later, Hot Dogs’ once thriving business has been decimated by a sudden shift in market demand away from heavily processed cured meats toward soy-based alternatives. Henry reacts by abandoning his wiener empire and taking a job as Chief Operating Officer at Thomas’s Tofurkey Corp., where he received a meaty $200,000 signing bonus and a $400,000 annual salary.
But what about the Bank? Assuming it can obtain a judgment against Henry on its guaranty, could it garnish his salary or the bank account into which he deposited the signing bonus? Unfortunately for the Bank, the answer under these facts is no. Because Wilma did not sign the guaranty, none of Henry and Wilma’s community property can be touched. Even though the Bank’s loan to Hot Dogs might have benefitted Henry and Wilma’s marital community (for example, by enabling Hot Dogs to operate and generate profits during its healthy years that fed Henry and Wilma’s lavish lifestyle), the lack of a guaranty signed by Wilma precludes any enforcement of the guaranty against the community property—truly, the “wurst case” scenario for the Bank.
The lesson here is simple, but it’s one that many lenders (particularly those based outside of Arizona) have learned the hard way. To bind a married couple’s community property to a guaranty in Arizona, both spouses must sign the guaranty. Otherwise, as long as that couple stays married (and each of them stays alive), collection is going to be limited to the signing spouse’s separate property, of which there may be little or none.
On the other hand, this is only true for couples who were married and domiciled in Arizona at the time the guaranty was signed, who remain in Arizona when the lender seeks to collect, and who keep all of their property in Arizona. What happens if that couple’s most valuable asset is their vacation home in Miami? What happens if a single person signs a guaranty and then gets married? What happens when a married person signs a guaranty outside of Arizona and then moves here? And what if one of them happens to be a former All-Pro defensive tackle whose nickname suggests you should think twice before trying to collect anything from him, regardless of your legal rights? Those questions and more will be answered in our next post.
About the Author: Bradley Pack is a shareholder with Engelman Berger. His practice includes representing lenders and borrowers in connection with loan disputes, workouts, insolvency, and bankruptcy matters; commercial litigation; and civil appeals.
HOW TO PLAY IN ARIZONA’S FINTECH SANDBOX – PART III: Who can Apply?
The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which started accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. This is the third in a five part series on how to apply for and participate in the sandbox. If you are new to the series, go back and read parts one and two, which discuss the history of sandbox programs and the benefits to participants of the Arizona sandbox. This part three will examine the eligibility requirements. Part four will explain the application process, and part five will address the rules once you are in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
The statute is very inclusive right from the start: “Any person may apply to enter the regulatory sandbox to test an innovation.” (Emphasis added). This includes not only startups or other new entrants to the Arizona market, but also established companies already licensed in the state. In fact, I expect that a sizable percentage of sandbox participants will be legacy banking institutions, as they will benefit equally from the opportunity to use Arizona as a testing ground for new products and services.
the use or incorporation of new or emerging technology or the reimagination of uses for existing technology to address a problem, provide a benefit or otherwise offer a product, service, business model or delivery mechanism that is not known by the attorney general to have a comparable widespread offering in this state.
We will have to wait and see how broadly the attorney general applies the requirement that the product or service be innovative. However, every formal statement by the attorney general’s office about the sandbox leads me to believe that it will be a very loose and inclusive assessment.
Is an entity or individual that is subject to the jurisdiction of the attorney general through incorporation, residency, presence agreement, or otherwise.
Has established a location, whether physical or virtual, that is adequately accessible to the attorney general, from which testing will be developed and performed and where all required records, documents and data will be maintained.
If accepted into the Sandbox, Applicant agrees to be bound by the requirements of Chapter 55 of Title 41 of the Arizona Revised Statutes and understands that Applicant and Active Managers will be required to acknowledge they are subject to the jurisdiction of the Arizona courts with respect to any action arising out of or relating to Applicant’s Testing.
First, incorporation simply means that the company is formed under the laws of Arizona. It could be argued that use of the term “incorporation” was meant to refer only to “corporations” formed under Title 10 and not limited liability companies under Title 29 (LLC’s are “organized” or “formed” rather than “incorporated”). However, given the otherwise inclusive language of the sandbox bill, which is open to any “person,” I don’t think the legislature intended to limit jurisdictional eligibility under the incorporation prong to Title 10 corporations, especially given that LLC’s organized in Arizona are generally subject to Arizona’s jurisdiction in other circumstances.
“Residency” generally means exactly what you would expect: if you are an individual that lives in Arizona full time, or if you are a company incorporated or organized in Arizona or whose principal place of business is in Arizona, then residency should be clearly satisfied. However, if you split time between Arizona and another state, or if you simply have some, but not all, business operations in Arizona, then determining your state of residence may involve a more complex legal analysis.
The final provision, “or otherwise,” is simply a catch-all provision that recognizes the many other ways people can become subject to the jurisdiction of a state. For example, if you are a foreign business, but you obtained a license to conduct certain business in Arizona, then by doing so you may have agreed to be subject to Arizona jurisdiction. Similarly, if you conduct significant ongoing business in Arizona, or if you have a significant presence in Arizona in the form of employees and/or offices, you may also be generally subject to jurisdiction in Arizona.
Location Must be Available to the Attorney General.
The second element requires the applicant to designate a specific place to develop and perform testing and to maintain all records, documents and data. This element is interesting in that it allows the applicant to designate a “physical or virtual” place – a savvy drafting decision by the legislature because it recognizes that many of these companies are going to be operating exclusively online.
It is not clear whether this element requires companies to give the attorney general access to original records and/or the exact same development and testing platform used by the company, or whether the company can simply create a copy for the attorney general’s use. In either case, it must be “adequately accessible” to the attorney general, and although that phrase is not specifically defined, I would expect that it will involve some measure of unfettered administrative access. I am including this component in our discussion of eligibility, but in actuality it is a requirement that can likely be satisfied after admission to the sandbox by coordinating with the attorney general to provide access.
The text of the fintech sandbox statute does not prohibit the admission of applicants with a criminal history, but it does require prior criminal convictions of the applicant or the applicant’s key personnel to be disclosed in the application. This suggests that criminal history will have some impact on the attorney general’s evaluation, but exactly how much is unknown. My guess is that applicants who have been convicted of financial or other white collar crimes may have difficulty getting admitted to the sandbox, particularly if that crime relates to the same financial sector the applicant’s fintech innovation would serve.
The attorney general will also evaluate applications in consultation with any agencies the innovation are or would be subject to, so if you already have a history of censures, investigations, or other negative agency actions, then your application may get rejected.
Whatever your background, applications should be completed thoroughly and carefully, which I will explore further in part four of this series.
HOW TO PLAY IN ARIZONA’S FINTECH SANDBOX – PART II: What’s the Benefit?
The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which started accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. This is the second in a five part series on how to apply and participate in the sandbox. If you are new to the series, go back and read part one, which gave a little background on sandbox programs implemented worldwide and efforts to create similar programs in the United States. This part two will discuss the benefits of participating in the Arizona sandbox. Part three will examine the eligibility requirements. Part four will explain the application process, and part five will address the rules once you are in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
The stated purpose of the sandbox is “to enable a person to obtain limited access to the market in this state to test innovative financial products or services without obtaining a license or other authorization that otherwise might be required.” A.R.S. § 41-5602. “Financial product or service” is defined to mean products or services in consumer lending, motor vehicle sales financing, or investment management, which are heavily regulated industries that generally require a state license to operate. A.R.S. § 41-5601(3). For example, Arizona consumer lenders must be licensed and pay annual licensing fees starting at $1,000. Money transmitters are similarly subject to licensing requirements, including annual fees starting at $1,500, and are only eligible for a license if they have a net worth exceeding $100,000 and satisfy a number of other requirements. The Arizona sandbox will allow fintech companies who would normally be subject to such licensure requirements to operate in Arizona without a license.
Less Regulation, Cheaper Costs, Fewer Penalties.
As unlicensed companies, sandbox participants are “not subject to state laws that regulate a financial product or service” except for those specifically identified in the sandbox statute. A.R.S. § 41-5605(F). For example, while consumer lenders will still need to comply with restrictions on finance charges and certain other loan terms, they will not need to provide annual reports and will not be subject to the normal penalty of $300/per violation of the state consumer disclosure requirements. Similarly, vehicle sales financiers who willfully fail to comply with any provision of A.R.S. § 44-281 et seq. would normally be penalized by losing the finance charge due under the loan, but participants in the sandbox will not be subject to that.
Money transmitters in the sandbox will not need to comply with any of the regulations in A.R.S. § 6-1201 et seq. Investment management companies will be exempt from the numerous state requirements set forth in A.R.S. § 44-3101 except for prohibitions on fraudulent practices and “dishonest and unethical practices,” rules governing custody of client funds and disclosure of information to clients, and requirements to maintain books and records in compliance with federal law. Notably, they will be exempt from administrative penalties and the other enforcement provisions in the statute.
The Growing Regulatory Mess: For Example – Money Transmitters.
The costs to get licensed and to comply with even well understood regulations can certainly deter tech companies from pursuing a new fintech project. However, the growing challenge for fintech companies is the lack of clarity about how existing regulations apply to new technologies. For a good example, look at money transmitter laws. Not so long ago, many companies and individuals dabbling in cryptocurrency would not have considered their activities to be subject to state or federal money transmitter laws. The IRS treats cryptocurrencies as property and not as currency. Similarly, the Commodity Futures Trading Commission (CFTC) has been of the opinion as early as 2015 that cryptocurrency is a commodity rather than a fiat currency. The District Court for the Eastern District of New York in CFTC v. McDonnell, No. 18-cv-0361 even recently adopted the CFTC’s view, which might lead a rational observer to conclude that trading cryptocurrency is not the transmission of “currency” subject to money transmitter laws.
Well that clears that up, right? Not so fast. On March 6, 2018, the same day the Eastern District of New York issued its ruling, the Financial Crimes Enforcement Network (FinCEN) published a letter it had penned the month prior stating that cryptocurrency token issuers may be money transmitters, and are therefore required to follow federal money transmitter requirements.
So how is a new cryptocurrency company supposed to proceed in light of inconsistent or unclear federal regulations, not to mention the even murkier application of state-by-state money transmitter laws? This is the type of problem fintech companies will routinely face, as the legal establishment struggles to figure out how to apply existing laws to new technologies that do not fit conveniently into previously established paradigms.
This is where the benefit of the Arizona fintech sandbox really come into focus. You don’t need to answer these tough questions right away. Instead, you get two years to test your product, and in that time you can work openly and collaboratively with the Arizona Attorney General and other governing regulatory authorities to figure out how your product fits into the regulatory framework. These exemptions can potentially provide substantial cost savings to sandbox participants. Most importantly, it will allow you to devote more of your focus and resources on development of your innovative product. Sandbox participants will still need to comply with sandbox-specific disclosure and recordkeeping requirements subject to the oversight of the Arizona Attorney General, which I will discuss at greater length in part four. However, these requirements are much easier to comply with than the normal regulatory regime.
HOW TO PLAY IN ARIZONA’S FINTECH SANDBOX – PART I: What is a Sandbox?
The Arizona legislature recently signed into law the nation’s first fintech regulatory sandbox, which will start accepting applications on August 3, 2018. Participants in the sandbox will enjoy a reprieve from many of the licensing and regulatory burdens of companies in the financial sector, so the program offers a great incentive for financial technology (aka, “fintech”) companies to settle and operate in Arizona. The purpose of the sandbox is to encourage businesses, including both startups and established companies, to develop innovative products and services in the financial sector.
If you are interested in participating in the sandbox, you may need some help. This is the first in a five part series on how to apply and participate in the sandbox. In this part one, I will give a little background on the history of sandbox programs implemented worldwide and efforts to create similar programs in the United States. Part two will discuss the benefits of participation in the Arizona sandbox. Part three will examine the eligibility requirements. Part four will explain the application process, and part five will address the rules once you are in the sandbox. The official website for the fintech sandbox was recently launched and can be viewed HERE, and the full text of the law can be viewed HERE.
The last couple of years have seen a wave of technological innovation that promises to revolutionize the financial sector. However, the financial sector is also one of the most highly regulated industries, making it very difficult for small, bootstrapped startups to enter the space. The challenge of navigating a myriad of overlapping and complex regulatory and statutory regimes, not to mention the threat of being slapped with crippling legal liability if you fail to comply, is often too much risk for a young entrepreneur to stomach. Compounding the deterrent effect of potential future liability, are the significant up-front legal costs associated with regulatory compliance (this is why people hate lawyers). When faced with that reality, too many entrepreneurs decide it would be easier to just work on safer projects, like another social networking app – and who can blame them?
To address this problem, a handful of countries have created programs dubbed regulatory “sandboxes,” so named because the programs create a regulation-free testing ground in which tech companies can play. Sandboxes provide participants with limited relief from a number of regulatory requirements, allowing participants to test innovative financial products under the close watch of a supervising government authority. Sandboxes are designed to lower the barriers to entry and decrease the time it takes to bring innovations to market, while still giving government sufficient oversight to ensure that consumers remain protected.
Despite successful efforts by the U.K., Singapore, U.A.E., Canada, and Australia, the United States has not created their own program. That changed on March 23, 2018, when Arizona Governor Doug Ducey signed into law House Bill 2434, making Arizona the first state to create a fintech sandbox. The Arizona Attorney General’s Office will start accepting applications to participate in the sandbox on August 3, 2018, so now is the time to start preparing to enroll. The official website was recently launched, and a preliminary draft of the sandbox application has been posted. Sandbox participants will generally have two years to test their product or service on up to 10,000 Arizona users, provided that they remain in good standing and comply with the sandbox rules.
Arizona’s sandbox program only exempts you from state, not federal, regulations. However, we might see the federal government roll out a federal program modeled on the Arizona sandbox in the near future. Paul Watkins, the chief counsel for the Arizona AG’s civil litigation division and the chief architect of the Arizona sandbox, was recently hired by the Consumer Financial Protection Bureau to serve as Director of their Office of Innovation and to guide the CFPB’s efforts to make a sandbox of its own. I have also personally heard Mr. Watkins speak about his hope that federal agencies will work with the Arizona AG’s office to provide a similar carve out from federal regulations for companies already participating in the Arizona sandbox, so I would not be surprised if one of his first projects with the CFPB is to implement a program like that.
By granting participants a reprieve from certain state regulations, the sandbox makes Arizona a very attractive place for fintech startups to test and launch their newest products. Perhaps best of all, fintech companies can trade the exorbitant up-front legal fees with a cheaper and more streamlined sandbox application. If you are a founder of a fintech startup, you may be saying to yourself, “that’s great! How can I play in the sandbox?” That is exactly the question I will answer in this four part series. In part two, I will address the most fundamental question: What’s the benefit? Is the juice worth the squeeze?

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