But Noncustomer Plaintiffs May Face Uphill Battle Proving Digital Currency Exchange’s Actual Liability

Earlier this week, the Eleventh Circuit affirmed, in an unpublished opinion, that Coinbase Inc., an online platform used for buying, selling, transferring, and storing digital currency, could not compel arbitration on a former customer of Cryptsy, a now-defunct cryptocurrency exchange, in his proposed class action suit alleging that Coinbase helped to launder $8 million of Cryptsy customers’ assets. Leidel v. Coinbase, Inc., Dkt. 17-12728.

In so holding, the Court found that the plaintiff’s allegations emanated not from the User Agreement between Coinbase and Cryptsy’s CEO, Paul Vernon, but from extra-contractual duties “allegedly” found in federal statutes and regulations, specifically the Bank Secrecy Act (“BSA”).  As we previously have blogged, courts have held that financial institutions generally do not owe a duty of care to a noncustomer and that no special duty of care arises from the duties and obligations set forth in the BSA absent a special relationship or contractual relationship. Moreover, there is no private right of action stemming from the BSA. Nor does the BSA define a financial institution’s standard of care for the purposes of a negligence claim.

Coinbase is registered as a Money Services Business with FinCEN, and is otherwise required to comply with the BSA. However, if courts treat Coinbase as it would any other financial institution (which we have no reason to believe that they would not), Plaintiff, having avoided the contractual arbitration provision, has an uphill battle to show that Coinbase had a duty of care to noncustomers to prevent AML failures.
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Australia announced on April 11 that all digital currency exchanges operating in the country will be regulated by the Transaction Reports and Analysis Centre (“AUSTRAC”), the country’s financial intelligence agency.  A byproduct of the government’s Anti-Money Laundering (“AML”) and Counter Terrorism Financing (“CTF”) Act (on which we previously have blogged, both here and here), the new laws require all “digital currency exchange providers” with operations in Australia to register with AUSTRAC and, additionally, meet compliance and reporting obligations by May 14.

AUSTRAC’s new policing mandate represents a meaningful step in strengthening the country’s efforts under the AML/CTF Act, first enacted in 2006.  In brief, that law—now applicable to all digital currency exchanges operating in Australia—requires all regulated entities such as banks and money transfer operators to collect information to establish a customer’s identity, monitor transactions, and report activity that is suspicious or involves cash over $10,000 Australian dollars.  As summarized by AUSTRAC on its website, the AML/CTF Act:

. . . . places a number of obligations on reporting entities when they provide designated services, including:

Reporting entities determine how they meet their obligations based on their assessment of the risk of whether providing a designated service to a customer may facilitate money laundering or terrorism financing.  These requirements echo similar AML regulatory requirements in the United States that require digital currency exchangers and administrators to register with FinCEN as money services businesses, and with the various States as money transmitter businesses.  AUSTRAC also has issued a guide for digital currency exchange service businesses to prepare and implement their AML/CTF programs.  The guide sets forth a check list of tasks necessary to developing and maintaining an adequate AML/CTF program, including the completion of a risk assessment of the business, designing a training program, and creating procedures for responding to AUSTRAC feedback.
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Last week, President Donald Trump issued an Executive Order banning “all transactions” and “dealings” by any individual or entity in the United States that involve “any digital currency, digital coin, or digital token” issued by Venezuela.  This Executive Order was instituted just under a month after President Nicholas Maduro launched the pre-sale of “petro,” a cryptocurrency backed by the Venezuelan government’s crude oil reserves.  Since its inception, the petro has been met with deep skepticism by both the market and the Venezuelan legislature, but President Maduro—through petro’s official website—claims it has raised over $735 million in its pre-sale.  The opposition in the Venezuelan legislature has denounced petro as an illegal issuance of debt.

We previously have blogged about alleged money-laundering violations by Venezuelan oilmen and OFAC’s designation of the Vice President of Venezuela as a Specially Designated Narcotics Trafficker.  This is only the most recent in a long line of sanctions targeting the Venezuelan government and its state-controlled oil industry.

On the back of this new Executive Order, the Office of Foreign Assets Control (“OFAC”) has issued new FAQs relating to virtual currency, both to regulate the petro and assert its power in the virtual currency space.  As one might suspect, OFAC has decided to treat virtual currency in the same way it treats fiat currency and other property: if the individual is on Specially Designated Nationals (“SDN”) list, transactions are barred no matter what form of currency is used.  If a United States citizen or entity is involved, or is otherwise subject to United States jurisdiction, they “are responsible for ensuring that they do not engage in unauthorized transactions prohibited by OFAC sanctions.”  The OFAC FAQs specifically request “technology companies; administrators, exchangers, and users of digital currencies; and other payment processors” to develop compliance plans.  Obviously, these compliance plans would have to take into account blockchain and virtual currency technology that is constantly evolving.
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As we previously have blogged, the Financial Crimes Enforcement Network (“FinCEN”) became one of the first regulators to wade into the regulation of cryptocurrency when it released interpretive guidance in March 2013 stating that an administrator or exchanger of virtual currency is a Money Services Business (“MSB”). As a MSB, and according to FinCEN, an administrator or exchanger of virtual currency therefore is a “financial institution” subject to the Bank Secrecy Act (“BSA”) and its various AML-related requirements, unless a limitation or exemption applies.  Accordingly, the Department of Justice has prosecuted operators of cryptocurrency exchanges for a failure to register with FinCEN as a MSB, and FinCEN has brought civil enforcement proceedings against such exchanges for alleged failures to maintain adequate AML programs and file required Suspicious Activity Reports (“SARS”), among other alleged BSA violations.

Recently, regulators of all stripes across the globe have been moving swiftly to regulate cryptocurrency in various ways (see herehere, here, here, here, here, here, here, and here). Indeed, the Securities and Exchange Commission (“SEC”) has been very vocal and aggressive in claiming that many if not all Initial Coin Offerings (“ICOs”) involving cryptocurrency represent securities subject to the jurisdiction and supervision of the SEC, and already has filed several enforcement proceedings involving ICOs. Moreover the SEC just yesterday issued a statement that it considers exchanges for cryptocurrency to also be subject to its jurisdiction. Likewise, the U.S. Commodity Futures Trading Commission (“CFTC”) has asserted that cryptocurrencies are commodities subject to its jurisdiction; this week, a federal court agreed with this assertion in a CFTC enforcement action.  The CFTC claims that its jurisdiction reaches beyond cryptocurrency derivative products to fraud and manipulation in the underlying cryptocurrency spot markets.

But there is a potential problem with all of these regulators simultaneously rushing in to assert their respective power over cryptocurrency businesses, and it is a tension that does not seem to have attracted much public attention to date. Specifically, BSA regulations pertaining to the definition of a MSB, at 31 C.F.R. § 1010.100(ff)(8)(ii), flatly state that a MSB does not include the following:

A person registered with, and functionally regulated or examined by, the SEC or the CFTC, or a foreign financial agency that engages in financial activities that, if conducted in the United States, would require the foreign financial agency to be registered with the SEC or CFTC[.]

How can certain cryptocurrency businesses be subject to the claimed jurisdictions of FinCEN as well as the recent regulatory newcomers to this area, the SEC and the CFTC?
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On February 23, the Financial Action Task Force (“FATF”) signaled that the inter-governmental body “will step up its efforts in monitoring the use of cryptocurrencies in money laundering.”  While the 37-member international body remains without an official policy for implementation, the pronouncement nonetheless demonstrates the heightened Anti-Money Laundering (“AML”) concern from regulators across the globe concerning illicit uses of cryptocurrency.

Notably, the FATF’s pronouncement comes on the heels of recent enforcement-related measures taken in various countries.  As we previously have blogged, the European Parliament and its executive arm, the European Council, recently agreed to an amendment to the Fourth Anti-Money Laundering Directive to include measures targeting exchange platforms for virtual currencies, such as Bitcoin, as well as prepaid cards.  More recently, France’s top financial markets regulator issued a statement that online trading platforms for cryptocurrency derivatives fall under the European Union’s central legislation regulating financial markets.  In the U.K., the Parliament’s Treasury Committee announced on February 22 that it has launched a probe to examine both the impact of cryptocurrencies on financial institutions and how best to police the new technology.  Meanwhile, South Korea’s ban on anonymous trading of cryptocurrencies—part of the country’s new policies which represent the first AML guidelines for cryptocurrencies among the nations of the FATF—took effect on January 30.
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This week, the U.S. Senate Committee on the Judiciary and the U.S. Senate Committee on Banking, Housing and Urban Affairs held hearings focused in part on Anti-Money Laundering  (“AML”) and the Bank Secrecy Act (“BSA”).  We discuss highlights of the testimony of the Chairpersons of the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”), as well as testimony from a senior official at the Justice Department and a representative of the U.S. Chamber of Commerce, concerning upcoming changes to beneficial ownership requirements and the current regulatory landscape of the cryptocurrency industry.
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As the value of bitcoin continues to soar (USD:BTC this past weekend exceeded $19,000.00:1), we thought that now would be a good time to emphasize the need to ensure regulatory compliance with the many federal and state AML rules and regulations, in addition to those segmented across various countries. A caveat: This post is far from exhaustive, and before undertaking any investment in cryptocurrency, it would be wise to consult with an attorney familiar with the rules applicable to the cryptocurrency sector.  Due to the nascency of the sector, the practical application of previously existing laws and regulations is rapidly evolving.

To begin, the notion that bitcoin and other digital tokens represent a currency only for criminals has been dispelled. Indeed, there is no question that investment in cryptocurrencies is inherently lawful and increasingly commonplace.  In 2017 alone, investment in initial coin offerings, or token sales, has exceeded $1.5 billion; in a similar vein, the value of certain cryptocurrencies now exceeds a number of Fortune 50 companies.  Most recently, CBOE and CME, the world’s largest futures exchange, launched bitcoin futures contracts.

With this in mind, and as we have written on this blog before (see herehere, here, here, here, here, here, here, and here), it is clear that regulators are moving aggressively to bring the cryptocurrency sector into the fold of existing rules and regulations. To be sure, applying these rules to the burgeoning sector has been like fitting a square peg in a round hole; a bedrock of the initial cryptocurrency boom was the promise of anonymity for its users. Conversely, identity verification is a bedrock of AML compliance.
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After over a year of negotiations, the European Parliament and its executive arm, the European Council, recently agreed to an amendment to the Fourth Anti-Money Laundering Directive to include measures targeting exchange platforms for virtual currencies, such as Bitcoin, as well as prepaid cards.  These new regulations will require an increase in transparency by the trusts and trading companies to reveal the holders of virtual currency to thwart potential money laundering, tax evasion, and anonymous funding of terrorism. Primary among these regulations is a requirement to provide beneficial ownership information to authorities and “any persons that can demonstrate a legitimate interest” to access data on the beneficial owners of trusts.

This focus on beneficial ownership in regards to virtual currency is entirely consistent with the general AML regulatory efforts in the United States and around the globe over the last few years, which have emphasized heavily the need to identify the beneficial owners of financial accounts, real estate and other assets in order to attain a more transparent financial system.

The regulation adopted by the European Parliament and European Council also comes as Bitcoin’s prices surged over 1,700 percent since the start of 2017.  This outstanding growth has increased main stream interest in the virtual currency while also sounding alarm bells as some fear that Bitcoin is a bubble bound to burst.  A key part of the amendment is that access to beneficial ownership information should be provided to authorities and “any persons that can demonstrate a legitimate interest.” 
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We are very pleased to be presenting on the topic of SEC enforcement against broker-dealers and mutual funds relating to alleged underlying Anti-Money Laundering and Bank Secrecy Act violations, and associated private class action lawsuits, at the upcoming meeting of the Securities Regulation Committee of the New York State Bar Association on this Wednesday, December

IRS Will Obtain Identifying Information Regarding Clients Who Conducted Any Transaction Equal to $20,000 or More

Last week, a federal magistrate judge in the Northern District of California granted in part and denied in part a motion by the IRS to enforce a “John Doe” summons served on Coinbase, Inc., which operates a virtual currency wallet and exchange business headquartered in San Francisco. As we have blogged, the court granted last year the IRS’s application to serve the summons on Coinbase, which then resisted and moved to quash. The recent ruling paves the way for potential criminal or civil tax investigations involving Coinbase customers, as well as potential money laundering investigations.  The ruling also indicates that the IRS might be able to seek more information from Coinbase about specific individuals as its investigation progresses.

Needless to say, the semi- or pseudo-anonymity offered by virtual currency – traits which historically have made virtual currency attractive to some of its users – are the same traits which have made the IRS and other law enforcement agencies and regulators intensely interested in the use of virtual currency. Although the use of virtual currency generally may cloak the user and create practical problems for investigators, the Coinbase action demonstrates that virtual currency is not truly anonymous in the face of a focused law enforcement inquiry.
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