Earlier this month, the leaders of the U.S. Commodity Futures Trading Commission, the Financial Crimes Enforcement Network, and the U.S. Securities and Exchange Commission released a joint statement reminding individuals engaged in transactions involving digital assets of their obligations under the Bank Secrecy Act (BSA) to guard against money laundering and counter the financing of terrorism.
Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) regulations apply to all entities that the BSA defines as “financial institutions,” including futures commission merchants and introducing brokers obligated to register with the CFTC, money services businesses as defined by FinCEN, and broker-dealers and mutual funds obligated to register with the SEC. To comply with AML/CFT regulations, financial institutions are required to, among other things, implement anti-money laundering programs and comply with recording keeping and reporting requirements, including suspicious activity reporting (SAR) requirements.
The joint statement emphasized that AML/CFT regulations apply to financial institutions engaged in activities involving “digital assets,” including instruments that may qualify under applicable U.S. laws as securities, commodities, and security- or commodity-based instruments such as futures or swaps. Because digital assets and financial transactions in digital assets are referred to by many names – including “cryptocurrencies,” “digital tokens,” “virtual assets” and “initial coin offerings” – the regulators issuing the joint statement reminded financial institutions that commonly used labels may not necessarily align with how an asset, activity or service is defined under the BSA or under laws and rules administered by the CFTC and the SEC. The nature of the digital asset, activity or service, including underlying “facts and circumstances” and the asset’s “economic reality and use,” determines how it is regulated under federal laws and regulations.
By reminding industry participants that the nature of a digital asset and the manner in which it is used – and not industry lingo – determines how the digital asset is regulated, the CFTC, FinCEN and the SEC signaled that they are adopting the same framework courts already use to determine how to classify other types of assets under the federal securities laws. The joint statement indicates that regulators are continuing to take steps toward applying existing federal securities laws and regulations to digital currencies.
Earlier this month, the Financial Crimes Enforcement Network (FinCEN) released new guidance to clarify when the Bank Secrecy Act (BSA) will apply to businesses that involve cryptocurrencies (what FinCEN refers to as convertible virtual currencies, or CVCs). The BSA imposes anti-money laundering obligations on various U.S. financial institutions, including “money services businesses” (MSBs). Under the BSA, businesses that transact in cryptocurrencies may qualify as money transmitters, a type of MSB. Whether a business qualifies is important. An MSB must register with FinCEN, implement anti-money laundering controls, and ensure ongoing compliance with recordkeeping and reporting requirements (potentially an expensive and burdensome exercise) – the consequences of failing do so can be severe. But determining which such businesses qualify has been difficult, leaving many in the crypto industry uncertain as to their regulatory status.
FinCEN previously sought to aid in this analysis when it issued guidance in 2013 on the application of the BSA to “persons administering, exchanging, or using virtual currencies.” Although it provided some insight into how FinCEN viewed the cryptocurrency industry, that guidance seemed to raise as many questions as it answered. Various administrative rulings – in which FinCEN publicly advised certain businesses as to whether they were MSBs – helped to answer some of those questions. But those narrow rulings have been few and far between and can provide only limited guidance for a rapidly evolving industry. Through public statements, government officials have also sought to clarify how the BSA might apply to crypto businesses. In particular, a February 2018 letter from a senior Treasury Department official to Senator Ron Wyden suggested that almost all ICOs will constitute BSA-regulated money transmission.
FinCEN’s new guidance “consolidates current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and then applies these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity.” In doing so it takes a step in the right direction, providing greater clarity as to FinCEN’s interpretation of its own regulations (at least to the extent your business model is one of the many covered). For example, the guidance describes why the provider of a hosted wallet likely will be an MSB by virtue of its exercise of total independent control over a customer’s cryptocurrency, whereas the provider of an unhosted wallet that vests the customer with total independent control likely will not. Similarly, the guidance explains that the operator of a trading platform that merely provides a forum where buyers and sellers can post bids and offers likely would not be an MSB, while the operator of a trading platform that additionally acts as an exchanger in consummating transactions between buyers and sellers likely would be. But gaps in FinCEN’s analysis still linger, new questions are raised, and it remains to be seen how useful this guidance will be as technology continues to advance and new and creative business models get off the ground.
And although the guidance signals that FinCEN is thinking about how the federal anti-money laundering laws apply to the cryptocurrency community, it does not signal how aggressive FinCEN will be in enforcing those laws against businesses that deal with cryptocurrency. To date, there have been just a handful of enforcement actions in the industry, including a civil penalty assessed against a peer-to-peer exchanger in April, which we previously discussed. One thing certain is that, in assessing potential BSA enforcement actions, FinCEN will rely heavily on this new guidance and expect businesses dealing in cryptocurrency to do the same. Persons and entities operating in this industry should evaluate (or reevaluate) whether they qualify as an MSB because of crypto-related activities in light of this new guidance.
Last week, the Financial Crimes Enforcement Network (FinCEN) backed up its strong public statements about enforcing the anti-money laundering (AML) laws with respect to cryptocurrency by bringing an enforcement action against an individual for violating the Bank Secrecy Act (BSA).
FinCEN, a bureau within the U.S. Department of Treasury tasked with safeguarding the financial system from illicit use and combating money laundering, has not been shy about expressing interest in blockchain and cryptocurrency issues. In a recent speech, Director Kenneth A. Blanco explained that “FinCEN has been at the forefront of ensuring that companies doing business in virtual currency meet their AML/CFT obligations regardless of the manner in which they do business.” He added that FinCEN “will continue to work with the SEC and CFTC to ensure compliance in this space and will not hesitate to take action when we see disregard for obligations under the BSA.” But FinCEN enforcement actions involving cryptocurrency activities have been infrequent. Since its landmark action against Ripple Labs in 2015, FinCEN’s only enforcement proceeding in this area was brought in 2017 against virtual currency exchanger BTC-e and its owner.
That changed last week when FinCEN assessed a civil penalty against Eric Powers, a “peer-to-peer exchanger” of virtual currency, for violations of the BSA. In agreeing to pay a $35,350 penalty, Powers admitted that he willfully violated the BSA by failing to (i) register as a money services business (MSB), (ii) implement written policies and procedures for ensuring BSA compliance, and (iii) report suspicious transactions and currency transactions.
The Powers action does not provide much insight into one of the more difficult questions a company whose business involves virtual currency faces: whether it qualifies as an MSB that is subject to the BSA. FinCEN guidance from 2013 indicates that the BSA generally will apply to “exchangers” and “administrators” of convertible virtual currencies. Unlike many virtual currency companies, Powers seems to have clearly fit within FinCEN’s definition of an exchanger – through online postings he advertised his intention to purchase and sell bitcoin for others, and he completed purchases and sales by delivering or receiving currency in person, through the mail, or via wire transfer. But in establishing that the BSA applied to Powers, FinCEN leans heavily on the 2013 guidance. That guidance in many ways is imprecise or unclear and it continues to create uncertainty as blockchain technology and virtual currency business models continue to evolve. But the Powers assessment confirms that other entities operating in the cryptocurrency space nevertheless should continue to evaluate their BSA obligations through the lens of that guidance to the extent possible.
Unlike those assessed against Ripple and BTC-e, the financial penalty assessed against Powers was relatively small. This might be because Powers was a natural person (potentially with a lesser “ability to pay” than larger incorporated entities), conducted a fairly small-scale operation, and paid larger sums as part of an earlier civil forfeiture action brought by the Maryland U.S. Attorney. While those considerations warranted a lesser penalty in Powers’s case, FinCEN very well could apply the same law, guidance, and reasoning underlying the assessment to more extensive cryptocurrency operations. Director Blanco’s recent comments regarding FinCEN’s priorities and this latest enforcement action suggest that FinCEN likely will do just that. In other words, we wouldn’t be surprised if FinCEN brings more enforcement actions – levying more severe penalties – to enforce the BSA in the cryptocurrency industry. Persons and entities operating in this industry thus should focus on assessing their potential BSA obligations early and take affirmative steps to comply if required.