Keyword: cryptocurrencies

CFPB Makes an Entrance: Crypto Products Targeted

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Ending doubts regarding its interest in the space, the Consumer Financial Protection Bureau (CFPB) has for the first time publicly acknowledged its investigation of a crypto company — and it’s likely a sign of things to come.

The agency hinted at increased enforcement in a summary of consumer crypto complaints in November 2022. The CFPB acknowledged an investigation for the first time that same month, when it published a decision in the case.

Crypto companies with direct-to-consumer products should take note — and consider steps to mitigate risk.

What Happened?

The CFPB sent a Civil Investigative Demand (CID) for testimony in December 2021 to Nexo, a cryptocurrency platform that offers an earned-interest product and lets customers make deposits.

The CID focused on whether Nexo made “false or misleading representations to consumers” about its safeguards used to protect crypto assets. The CFPB also stated that the investigation included potential violations of the Electronic Funds Transfer Act, confirming its view that the law applies to crypto assets.

Nexo filed a petition to set aside or modify the CID. It argued that the SEC views interest-bearing crypto accounts as securities that are subject to SEC regulation and exempt from CFPB jurisdiction.

CFPB Director Rohit Chopra denied the petition. He noted that Nexo had been unwilling to fully concede that its product was a security subject to SEC regulation and that “it [was] too early to tell whether Nexo … was required to be registered with the SEC,” and exempt from the CFPB’s jurisdiction.

Since then, Nexo announced it had made “the regrettable but necessary decision” to phase out its products and services in the U.S. after “inconsistent and changing positions among state and federal regulators.”

What does this mean?

Though this is the first publicly identified CFPB crypto investigation, there are likely more on its docket.

This matter also reveals that CFPB crypto investigations have been ongoing since at least the fourth quarter of 2021. Less than two weeks before issuing the Nexo decision, the CFPB issued a Crypto-asset Complaint Bulletin. The CFPB typically uses these bulletins to notify a market of its plans to address certain types of consumer harm. Three top crypto complaint themes likely to trigger CFPB interest include:

  1. Fraud: 40% of consumer complaints in the bulletin were a result of having been victimized by fraudulent activity or scams in the crypto ecosystem.
  2. Access to Funds: Many consumers reported struggling to access their funds due to issues with crypto platforms and the freezing of funds before filing for bankruptcy protection.
  3. Poor Customer Service: A major issue cited in the complaint bulletin was the inherent lack of customer service provided to consumers in the crypto market. Consumers described company customer service as non-responsive or non-existent. The CFPB launched an initiative to improve customer service this year with Director Chopra’s stated goal “to ensure the legally enshrined right to obtain basic customer service.”

Looking Forward

We expect increased enforcement action aimed at addressing the themes in the Crypto-asset Complaint Bulletin. Crypto companies that have not affirmatively subjected themselves to SEC or CFTC authority may be more vulnerable to CFPB scrutiny. In an environment of increased regulatory risk, we recommend that crypto companies review their products and services from a consumer/end user perspective and pay attention to customer complaints.

Contact Melissa Baal Guidorizzi and Daniel Forester if you have any questions regarding recent regulatory trends and best practices for building compliance programs if your company is subject to the CFPB’s enforcement and examination powers.

Cryptocurrency Transactions and Taxes: 5 Things to Know

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The $1.2 trillion Infrastructure Investment and Jobs Act – also called the Bipartisan Infrastructure Law –garnered attention with its promise to tackle an array of projects, from rebuilding roads and bridges to broadening high-speed internet access.

Provisions in the law that relate to taxing cryptocurrency transactions, however, received less notice. Those measures seek to ensure that taxpayers properly report and pay tax on crypto-related income.

Here’s what you need to know:

1. The law redefines “broker” and views digital assets as “specified securities”

The Infrastructure Act makes two significant changes to Section 6045 of the Internal Revenue Code (IRC). That section requires brokers to report gross proceeds from transactions to the taxpayer and to the IRS. If the item subject to reporting is a “covered security,” the broker must report the customer’s adjusted basis in the security and say whether a gain or loss is long- or short-term. Covered securities are further defined to include “specified securities,” such as stocks, bonds, commodities and other financial instruments.

The Infrastructure Act:

  • Includes digital assets in a list of specified securities. The law defines “digital asset” as “any digital representation of value which is recorded on a cryptographically secured distributed ledger” or similar technology. The definition of digital asset is significant as that term is used in a number of other provisions in the Internal Revenue Code.
  • The provision covers a broad category of digital assets, including traditional cryptocurrencies like bitcoin as well as non-fungible tokens. The Treasury Secretary has authority to exempt types of transactions.
  • Modifies the definition of “broker” to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”
    • The use of “on behalf another person” is perplexing because the broker already includes a “middleman” concept. On its face, the updated provision would require miners, software developers, transaction validators and node operators to provide information because they provide services in connection with crypto transactions on behalf of users of the software.

2. The law expands reporting requirements to encompass “broker-to-non-broker” transactions

IRC Section 6045A deals with reporting transactions between brokers. It requires every “applicable person” who transfers a covered security (including the “specified securities” discussed above) to a broker to furnish information so the transferee can provide required gain or loss and basis reporting information. The Infrastructure Act expands reporting to cover “broker-to-non-broker” transactions.

3. People receiving more than $10K in digital assets now need to report

IRC Section 6050I requires anyone receiving more than $10,000 in cash in a “trade or business” to report it to the IRS via Form 8300, and to provide a written statement to the payer. It also covers “to the extent provided in regulations” any monetary instrument (whether or not in bearer form) with a face amount of not more than $10,000. Failure to report cash transactions can trigger steep penalties.

The Infrastructure Act amends the Code so that the reporting requirement also applies to people receiving digital assets.

4. It’s not always easy to identify someone who buys a digital asset

Broadening IRC Section 6050I to apply to people receiving digital assets is consistent with the changes described above to Section 6045: viewing digital assets as a specified security and requiring brokers to report information on certain digital transactions.

On the surface, the law’s reporting requirement would apply to people receiving digital assets for validating transactions or other services relating to crypto transactions.

One of the problems this introduces in the world of decentralized finance transactions is the difficulty of identifying the purchaser if the transaction is made through a smart contract rather than from an identifiable person.  Often times these transactions are entered into on an “open” and “trust-less” basis (meaning that there are no limits as to who can participate in the transaction) making it difficult or impossible to report on who the counterparty is (other than by identifying the blockchain wallet address involved in the transaction).

5. Information-gathering starts Jan. 1, 2023

The changes take effect for returns that must be filed and statements that must be furnished after Dec. 31, 2023. Gathering information for that, though, should start Jan. 1, 2023.

The Next Step: FinCEN Proposes to Require Reporting of Cryptocurrency Positions Held in Foreign Accounts

FinCEN recently took another important step toward bringing virtual currency into the financial assets reporting scheme.

Taxpayers that have $10,000 or more in a foreign bank account have long been required to file a foreign bank account report (or “FBAR”) on FinCEN Form 114. The penalties for failing to report foreign bank accounts are significant: $10,000 for a non-willful failure and the greater of $100,000 and up to 50 percent of the unreported account balance for willful failures. While the rules requiring the reporting are issued under the authority of the Bank Secrecy Act, the IRS administers the rules—and the IRS has been aggressive in assessing penalties for failures to report such holdings.

The application of the filing requirement to cryptocurrency has been the subject of some uncertainty. The uncertainty arises because the reporting requirement only applies to a “financial account.” A financial account includes, but is not limited to, a se­curities, brokerage, savings, demand, checking, deposit, time deposit or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account (per 31 CFR 1010.350(c)) also includes a commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value and shares in a mutual fund or similar pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions). The regulations reserve “other investment fund,” presumably for a definition to come. However, in response to questions raised by the AICPA Virtual Currency Task Force in 2019, FinCEN stated that virtual currency was not subject to FBAR reporting. This was confirmed by FinCEN in 2020 as well.

Whether or not cryptocurrencies are subject to FBAR filing, such holdings may have to be included on the IRS’s Form 8938, Statement of Specified Foreign Financial Assets. Form 8938 is the counterpart to FinCEN 114.

Recent FinCEN Proposed Rule

On December 31, 2020, FinCEN issued Notice 2020-2 that announced a proposed rule that would amend the regulations implementing the Bank Secrecy Act regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350. The proposed rule does not specify an effective date.

The decision to treat cryptocurrency as subject to FBAR reporting significantly increases the potential penalties against those who fail to properly identify these accounts. Holders of virtual currency in foreign accounts should review this rule and prepare to report such holdings once the rule becomes effective.

FinCEN’s New Guidance for Cryptocurrency Businesses – Some Questions Answered, Some New Questions Raised, Careful Consideration a Must

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.