Bitpay claims to operate as a payment processor: a business that only facilitates payment by customers to a merchant for that merchant's goods and services. Payment processors are exempt from MSB regulations at the federal level.
On that model, a merchant using Bitpay would never handle BTC, assuming they opt for payment from Bitpay via a wire transfer in USD. The merchant in this scenario would not be an MSB either.
Yes that makes sense that the Merchant never physically accepts the BitCoin. Wouldn't BitPay though fall under the category of exchange and therefore a MSB? BitPay says that is has contractual agreements with the Sellers. Can't it be argued that BitPay is acting on behalf of the Merchant, and therefore the merchant is actually exchanging BitCoin into Fiat?
If BitPay received Bitcoin from client and transferred said BitCoin to merchant than it's perfectly fine, but when they take that clients BitCoin and exchange it for USD, an exchange has occurred. Would they be considered a Money Service Business under FinCen guidance?
An exchanging from digital currency to fiat is occurring, the issue is who is liable for these actions occurring, it would seem that BitPay is acting on behalf of it's merchants who order it to facilitate the exchange and the merchant can be considered an MSB? It seems one or the other has to be considered an MSB as an exchange is occurring.
Also, re-reading what you wrote even if they are exempt of MSB regulations at the federal level, that necessarily does not mean that they are exempt from the State level.