Why it matters: On May 5, 2015, the DOJ announced that it had entered into a settlement agreement with virtual currency exchanger Ripple Labs, Inc. and its subsidiary to resolve allegations that the company failed to register as a money services business with FinCen and failed to establish both an appropriate anti-money laundering program and procedures to report suspicious activity as required by the Bank Secrecy Act. The settlement arose from coordinated criminal and civil enforcement actions involving the DOJ, IRS and FinCen, and constituted the first civil enforcement action by FinCen against a virtual currency exchange. Which raises the question: Will this settlement have a Ripple effect in the virtual currency industry?
Detailed discussion: On May 5, 2015, the DOJ announced that it had entered into a three-year settlement agreement with San Francisco-based virtual currency exchanger Ripple Labs Inc. (Ripple) and its wholly-owned subsidiary XRP II LLC (XRP II), to resolve criminal allegations that Ripple and XRP II violated the Bank Secrecy Act (BSA) when they failed to register their virtual currency exchange company as a money services business (MSB) with FinCen and failed to institute and maintain both an appropriate anti-money laundering (AML) program and procedures to report suspicious financial transactions. The settlement agreement requires Ripple to pay FinCen a civil money penalty of $700,000 and the U.S. Attorney’s Office a forfeiture amount of $450,000 (the forfeiture amount is “deemed creditable” toward FinCen’s civil money penalty). Ripple and XRP II must also institute a series of substantial remedial measures and cooperate with the government in other investigations. The criminal enforcement action against Ripple was conducted jointly by the U.S. Attorney’s Office in San Francisco and the IRS’s Criminal Investigation Division, while FinCEN conducted a parallel civil enforcement action. In a separate press release on May 5, FinCen emphasized that this was its first civil enforcement action against a virtual currency exchanger.
The agreed Statement of Facts set forth in an attachment to the settlement agreement details that, in March and April 2013, Ripple engaged in the exchange of its “pre-mined” virtual currency known as “XRP.” In August 2013, Ripple began running its virtual currency business through its wholly-owned subsidiary XRP II. The findings show that, as of 2015, XRP is the second-largest “cryptocurrency” by market capitalization, behind only Bitcoin.
Relevant to the government investigation, Ripple defined itself in federal court filings in an unrelated case as “a currency exchange service providing on-line, real-time currency trading and cash management…[it] facilitates the transfers of electronic cash equivalents and provides virtual currency exchange transaction services for transferrable electronic cash equivalent units having a specified cash value.”
In February 2013, FinCen released guidance specifically clarifying that virtual currency “exchangers” and “administrators” are money service businesses (MSBs) that are subject to the requirements of the BSA and are required to register with FinCen. Moreover, the BSA requires MSBs, whether registered with FinCen or not, to “develop, implement and maintain” an effective AML program (including “Know-Your-Customer/Know-Your-Counterparty procedures), as well as suspicious activity reporting procedures under the Funds Transfer and Funds Travel Rules.
The findings show that during the time it was operating as a virtual currency exchanger in March and April 2013, Ripple did not register with FinCen as an MSB, nor did it have an AML program or suspicious activity reporting procedures in place, despite facilitating multiple XRP transactions exceeding $1.3 million. Ripple formed its subsidiary XRP II in July 2013 and began running its virtual currency exchange business through it by the beginning of August 2013; however, XRP II was not registered as an MSB with FinCen until September 4, 2013. XRP II was also found to have failed to (1) develop a written AML program until late-September 2013, (2) hire an AML compliance officer until January 2014, or (3) conduct an AML risk assessment until March 2014. The findings also show that it wasn’t until approximately August 2014, i.e., a full year after XRP II began conducting its virtual currency business and only after Ripple had learned that it was the subject of a federal criminal investigation, that XRP II began training employees and conducting an independent review of its AML program. During that same time, XRP II was also found to have failed to file suspicious activity reports under the BSA Funds Transfer and Travel Rules when such filings were clearly warranted.
In addition to paying the penalty and forfeiture amount totaling $700,000, Ripple and XRP II are also obligated under the settlement agreement to take extensive remedial measures, including (1) “migrating” their XRP currency exchange service known as “Ripple Trade” (formerly “Ripple Wallet”) to an MSB that is registered with FinCen, (2) implementing and maintaining an effective AML program, hiring an AML compliance officer and creating an effective AML employee training program, (3) submitting to three separate audits (in 2015, 2018 and 2020) of the company’s BSA compliance programs to be conducted by an independent, external reviewer, and (4) conducting a “look-back” for suspicious activity within the prior three years and instituting and maintaining procedures for transaction monitoring and suspicious activity reporting going forward in compliance with the Funds Transfer and Funds Travel Rules.
The fact that this settlement occurred in the uncharted waters of the growing virtual currency industry did not go uncommented on. As U.S. Attorney for the Northern District of California Melinda Haag said in the press release, “[w]e hope that this sets an industry standard in the important new space of digital currency.” FinCen Director Jennifer Shasky Calvery added that “[v]irtual currency exchangers must bring products to market that comply with our anti-money laundering laws… Innovation is laudable but only as long as it does not unreasonably expose our financial system to tech-smart criminals eager to abuse the latest and most complex products.” In addition, Chief Richard Weber of the IRS Criminal Investigation Division invoked images of sheriffs versus gunslingers in the old American West when he said that “[u]nregulated, virtual currency opens the door for criminals to anonymously conduct illegal activities online, eroding our financial systems and creating a Wild West environment where following the law is a choice rather than a requirement.”
On May 6, the day after the announcement of the Ripple settlement, FinCen Director Calvery spoke at the West Coast AML Forum in San Francisco, expounding on the Ripple enforcement action and FinCen’s ongoing efforts to investigate and reign in the developing virtual currency industry. She implied that there may be more such enforcement actions in the works, saying that “FinCEN recently launched a series of supervisory examinations of businesses in the virtual currency industry…these exams will help FinCEN determine whether virtual currency exchangers and administrators are meeting their compliance obligations under the applicable rules. Where we identify problems, we will use our supervisory and enforcement authorities to appropriately penalize non-compliance and drive compliance improvements.” A ripple effect, indeed.
See here to read the DOJ press release dated 5/5/15 entitled “Ripple Labs Inc. Resolves Criminal Investigation.”
See here to read the Settlement Agreement dated 5/5/15 between the U.S. and Ripple Labs Inc., including Statement of Facts and Violations attached as Attachment A.
For more on this matter, refer to the following:
FinCen press release dated 5/5/15 entitled “FinCen Fines Ripple Labs Inc. in First Civil Enforcement Action Against a Virtual Currency Exchanger.”
Remarks of FinCen Director Jennifer Shasky Calvery at the West Coast AML Forum on 5/5/15.