Permissible Investments

If a customer sends you a dollar to transfer, that dollar doesn't teleport from sender to recipient. It sits in your account, in your control, for minutes or hours or sometimes days. That customer dollar is a liability to you—you owe that money to the recipient. While it's in your account, it's not your money to spend. Regulators want to make sure that money is not deployed in ways that expose the customer to loss.

Permissible investments are the regulatory answer to the question: what can you do with customer funds while they're sitting in your account? The answer is: not much. You can put them in low-risk, highly liquid investments. You can't use them for short-term trading, you can't invest them in equity markets, and you certainly can't use them for business operations. The regulator's philosophy is that customer funds are sacred, and your interest in deploying them for profit is subordinate to the customer's interest in getting that money safely transferred.

This concept doesn't exist universally. Federal law (FinCEN, under the Bank Secrecy Act) doesn't impose permissible investment restrictions. But every state that licenses money transmitters imposes some version of this requirement. The specific rules vary wildly.

What Permissible Investments Are and Why They Matter

A permissible investment is an investment in which customer funds can be held without exposing the customer to loss of principal. The regulator is not concerned with your profitability on those funds. The regulator is concerned with safety. The customer has no contract with you regarding return on the funds. The customer expects the funds to be available on demand. Permissible investments reflect that priority.

Permissible investments typically include bank deposits, money market funds, US Treasury obligations, and sometimes state or municipal securities. Permissible investments typically exclude stocks, bonds from private companies, derivatives, or anything with material market risk.

The concept of permissible investments directly addresses what regulators call "customer fund segregation." The principle is this: money that belongs to customers must be segregated from money that belongs to you. It must be invested separately, tracked separately, and remain available to satisfy customer claims. If you comingle customer funds with your operational funds, or if you invest customer funds in risky assets, you're violating the segregation principle.

In practical terms, this means you need separate accounts for customer funds and operational funds. Customer funds go into a segregated account. Operational funds go into a separate account. The segregated account is invested conservatively. The operational account is invested however you see fit.

The reality is more nuanced. Most money transmitters run multiple customer accounts (one per state, for example, because some states require it). Some run separate accounts for different types of customers. All of these accounts contain customer funds that must be segregated.

The Concept of Customer Funds Segregation

Customer funds segregation is not a new concept. It exists in futures trading, in brokerage, and in escrow services. The money services industry adapted it from those industries.

The principle is straightforward: funds that don't belong to you must be held separately from funds that do. This is a balance sheet issue and a control issue. On the balance sheet, customer funds appear as a liability—you owe that money to the customer or to the recipient. Your operational funds appear as equity or revenue. Never the twain shall meet.

In practice, this means you maintain what's sometimes called a "custodial account" or "trust account" for customer funds. The account is held in your name as agent, but the funds are deemed to be held in trust for the customer. Most states require explicit trust account language in the account title: "Company Name, FBO [for the benefit of] Customers" or "Company Name, Custodian for Customers."

This has real consequences. If you go bankrupt, the bankruptcy trustee cannot touch customer funds in a trust account. They belong to the customers. Your creditors cannot attach the trust account. If a customer sues you, their claim is against your operational assets, not against customer funds.

If you fail to maintain proper segregation, you're in violation. The regulator can find that during an examination. Even without evidence of actual commingling, if your account structures don't clearly reflect segregation, you're at risk. I worked with a company that held customer funds in an account titled simply "Company Name Operating Account." There was no indication that the account held customer funds. When the regulator noticed this during examination, it was a finding. The company had to restructure immediately.

Proper segregation requires: - Separate accounts clearly identified as holding customer funds - Account titles that reflect the custodial nature ("FBO," "Custodian for," "Held in Trust," etc.) - Clear internal tracking that distinguishes customer funds from operational funds - Investment policies that reflect segregation requirements - Bank or custodian that understands it's holding customer funds

Types of Permissible Investments by State

The specifics vary materially across states. I'll address the key states and the major variations.

New York requires customer funds to be held in deposits with federally insured banks, money market mutual funds that hold only permitted investments, or certain government securities. New York's term is "permitted investments," and the list is strict. No corporate debt, no equity, no derivatives, no commodity futures. The only flexibility is in money market mutual funds, and those are limited to funds that invest exclusively in US Treasury obligations and high-quality commercial paper (rated A-1 or equivalent by a major rating agency). This is one of the strictest regimes.

California requires customer funds to be segregated and invested in accounts at federally insured banks, securities registered with the SEC (limited to certain government securities), money market accounts, or customer accounts with certain broker-dealers if the funds are held in trust. California allows a bit more flexibility than New York but still forbids equity exposure and requires federal insurance backing. California also has a practical requirement: California regulators want to know exactly how much customer funds are on hand at any given moment, which means you need clear daily accounting.

Texas allows customer funds to be held in deposits at federally insured banks or in permitted investments, which include US Treasury securities, federal agency securities, and certain highly rated municipal securities. Texas is slightly more permissive than California on the types of securities allowed, but the principle is the same: no equity, no speculative risk.

Illinois and Florida allow similar regimes: federally insured bank deposits, US Treasury obligations, and certain municipal or agency securities. Both states allow some flexibility in municipal security selection, provided the securities are rated A or better.

Nevada is more permissive. Nevada allows customer funds to be held in federally insured bank deposits, permitted investments (similar to other states), or in the company's own segregated account if the company maintains sufficient net worth. Nevada's leniency here reflects its broader philosophy of lighter-touch regulation.

Wyoming also allows flexible arrangements, including segregated accounts held for customers' benefit, provided the company maintains net worth above the surety bond requirement.

The practical difference is manageable. Across most major states, you can operate with customer funds held in bank deposits and US Treasury funds. That's simple, liquid, and meets every state's requirements.

How Permissible Investment Requirements Scale with Transaction Volume

Most states don't explicitly scale permissible investment requirements by transaction volume. They simply require that all customer funds be held in permissible investments. But there's an implicit scaling mechanism.

The larger the amounts you're holding, the more likely it is that you'll run into state-specific constraints. A small company holding $100,000 in customer funds can easily park that in a money market account. A large company holding $50 million needs something more sophisticated.

Some states implicitly allow more flexibility for larger operators. California has sophisticated guidance for large money transmitters about how to invest large volumes of customer funds. The guidance recognizes that a $50 million position in a single money market fund creates practical constraints. California allows large operators to spread funds across multiple accounts and investments, provided all are permissible.

The constraint becomes most acute when scaling across multiple states. If you maintain separate customer accounts in each state (because some states require it), and each account must hold permissible investments, you end up managing customer funds across ten, twenty, or fifty separate accounts. The operational complexity increases with scale.

I worked with a national operator that maintained customer accounts in fifteen states. Each state required a separate account. Each account had to hold permissible investments. The operator ended up managing over thirty accounts across multiple banks to maintain segregation and meet state requirements. The operational overhead—reconciliations, monthly certifications to regulators, audit procedures—was substantial.

The practical effect is that companies scaling nationally need accounting and banking infrastructure to support multiple permissible investment accounts across multiple states. This is not inherently expensive, but it does require planning.

The Relationship Between Permissible Investments and Net Worth

These two concepts interact in important ways.

First, permissible investment requirements exist, in part, because net worth requirements don't fully protect customers. If you have net worth requirements but allow speculative investments of customer funds, you create a scenario where the company's shareholders have upside from customer funds. That's not acceptable. So permissible investment restrictions prevent you from profiting from customer funds, while net worth requirements ensure you have your own capital at risk.

Second, the size of permissible investment accounts directly correlates to customer balances held, which correlates to surety bond requirements in some states. If you're holding $10 million in customer funds because you have high customer balances, that creates a surety bond requirement in many states. So the decision to hold high customer balances has downstream effects on capital requirements.

Third, permissible investment requirements can interact with net worth calculation. Some states allow you to count segregated customer fund accounts as part of your asset base for net worth calculation purposes. Texas does this. Some states don't. New York specifically excludes customer funds from net worth calculation. You can't count a dollar that you're holding in trust as your own equity.

The practical point: if you're designing your capital and investment structure, understand how these three elements—net worth, surety bonds, and permissible investments—interact in your target states. They're not independent requirements; they're linked mechanisms all designed to ensure customer funds are protected.

Practical Strategies for Managing Permissible Investments

The simplest strategy is to hold customer funds in FDIC-insured bank accounts earning minimal interest. This is compliant everywhere, simple to account for, and liquid on demand. The downside is that you earn nothing on customer funds, while you're holding them. But you also take no investment risk.

Some companies argue that the interest earned on customer balances belongs to the company, not the customer. This depends on the contract and state law. If the customer agreement specifies that the company retains interest, many states allow this. If the agreement is silent, some states assume the interest belongs to the customer. The practical approach is to specify in your customer agreement whether interest is retained by the company or passed to the customer. If you're going to keep interest, say so explicitly.

For companies holding large customer balances, holding funds in bank deposits becomes inefficient. Bank deposit insurance is limited to $250,000 per customer per bank. If you're holding $50 million in customer funds, you need 200 separate FDIC-insured accounts to ensure full insurance coverage. That's unmanageable.

The solution is to use money market funds or Treasury funds. Money market mutual funds can hold very large amounts, they're liquid, and they're relatively safe if they're invested in the right securities. A money market fund invested exclusively in US Treasury obligations or high-quality commercial paper is permissible in most states. The fund can hold $50 million, $100 million, or more. Your interest is minimal—money market rates are typically below 1 percent—but the simplicity and liquidity are worthwhile.

Some large national operators use Treasury laddering: they invest customer funds in a mix of short-term Treasury bills, notes, and bonds, structured so that portions mature on different dates. This creates a steady flow of maturing investments, which can be reinvested or deployed to fulfill customer withdrawal or transfer requests. This is more sophisticated but necessary for very large operations.

For companies operating in California specifically, there's an additional requirement: daily reconciliation and monthly certification to the regulator showing the amount of customer funds on hand and their investment allocation. This is managed through formal compliance documentation. If you're operating in California, plan for administrative overhead.

The key principle in all strategies is simplicity and clarity. Your permissible investment accounts should be easy to audit, easy to reconcile, and easy to explain to a regulator. Complexity creates audit issues. Choose the simplest permissible investment approach that works for your scale.

What Examiners Look for During Reviews

Examiners review permissible investment accounts during examination. They're looking for specific things.

First, account structure. Is the account clearly titled as a customer or trust account? Is the bank documentation clear that this is a customer fund account? If not, the examiner will flag it. The title matters.

Second, segregation. Are customer funds commingled with operational funds? The examiner will compare the account titles and trace funds. If they find evidence of commingling, it's a finding. Even if the commingling is inadvertent or temporary, it's still a problem.

Third, investment allocation. What's actually in the account? If you claim the funds are in permissible investments, the examiner will verify that. They'll request account statements and investment holdings. If you claim to have funds in a money market account, they'll verify the account exists and holds the amount claimed. If you claim Treasury holdings, they'll verify the holdings match the customer balance.

Fourth, reconciliation. Does your accounting match the bank accounts? The examiner will compare your internal records of customer balances to the actual bank account balances. If there's a discrepancy, the examiner will want to understand why. A systematic discrepancy suggests accounting or reconciliation problems.

Fifth, customer balance documentation. For companies holding large customer balances, the examiner will review your customer account ledgers to understand who holds what. They're checking whether your customer data matches your customer fund balance. If your accounting shows $10 million in customer balances but the bank shows $15 million, the examiner will be concerned.

Sixth, compliance with state-specific requirements. If you're operating in California and you haven't provided the monthly certification of customer funds, the examiner will note that as a finding. If you're operating in New York and you're holding funds in investments outside the permitted list, that's a finding.

Examiners are not trying to catch you in a trap. They're verifying that customer funds are protected. But they're thorough, and they document everything. If there's any deviation from requirements, it becomes a finding. If findings pile up, you can face a cease and desist order or license revocation.

To stay clean: maintain clear account documentation, reconcile accounts monthly, ensure all investments are permissible in every state where you're licensed, and prepare monthly or quarterly compliance certifications for regulators that request them.