The Financial Crimes Enforcement Network of the US Department of Treasury published a comprehensive overview of its regulations and previously published guidance related to how individuals and firms may have to comply with obligations for money transmitters to the extent they engage in businesses involving so-called “convertible virtual currencies” ("CVC").

Generally FinCEN requires any person engaging in the business of money transmission or the transfer of funds, including CVC, to (1) maintain an “effective” written anti-money laundering program reasonably designed to prevent the business from being employed to help the financing of terrorist activities and money laundering and (2) register as a money service business. A firm or individual engages in money transmission, says FinCEN, when it receives one form of value (including CVC) from a person and transmits it in the same or different form to another person or location by any means. FinCEN concludes, for example, that, applying this definition, a business operates as a money transmitter when it accepts fiat currency from a person and transfers the CVC to the person’s CVC account with the business.

FinCEN defines CVC as any medium of exchange that functions like currency but does not have all the attributes of fiat currency, including constituting legal tender. FinCEN noted that, while CVC may include instruments referred to as digital currencies, cryptocurrencies and digital assets, the naming of an instrument “is not dispositive of its regulatory treatment.” Likewise, said FinCEN, it is the business model of a person engaging in activities regarding CVC that dictates obligations of money transmitters, not the “label used by industry to designate a general type of product or service.”

FinCEN’s guidance provides numerous examples of when a CVC business constitutes money transmitting and when it does not, concentrating mostly on the activities of three types of businesses: (1) wallet providers; (2) money transmission services utilizing electronic kiosks and decentralized applications; and (3) trading platforms and decentralized exchanges.  The guidance also discusses money transmission engaged in connection with project fundraising, such as initial coin offerings. For all businesses, the key determining factor appears to be whether the business is touching CVC as part of a transmission, or is simply helping persons effectuate a transmission themselves. The former activity generally constitutes money transmission, the latter does not.

Separately, FinCEN also issued an advisory to aid financial institutions, including MSBs handling CVC, identify suspicious activities involving CVC. Typically financial institutions are obligated to report all suspicious activities to FinCEN. Among other things, the advisory describes how so-called “darknet marketplaces” are often interposed in many illegal activities; sets forth a list of 30 red flags of potential abuses using CVC; and identifies certain required and helpful information that should be included in all suspicious activity reports involving CVC that are filed with FinCEN. (Darknet marketplaces reference anonymized locations on the Internet that are not indexed by traditional search engines and typically require special software to access.)

Among red flags of potential suspicious activity involving CVC identified by FinCEN is a customer receiving a number of deposits from different sources in a relatively short time that in total equal the aggregate amount of funds transferred to a known virtual currency exchange; a customer’s transactions emanating from a non-trusted IP address, an IP address associated with a sanctioned jurisdiction or an IP address previously identified as suspicious; and a customer using identification or account credentials (e.g., unique password, IP address or flash cookies) employed by another account. FinCEN also noted as a red flag a customer “significantly older than the average age of platform users” opening a cryptocurrency transaction account and engaging in a large number of transactions. This behavior, suggested FinCEN, may indicate the person’s role as a “CVC money mule” or as a victim of an elderly financial exploitation scam.

In other legal and regulatory developments regarding cryptoassets:

  • SEC Crypto Guidance Employing Jackson Pollock Techniques Too Cryptic Says Commissioner Hester Peirce: Hester Peirce, Commissioner of the Securities and Exchange Commission, expressed her skepticism regarding the Commission’s recently issued framework regarding when cryptoassets may constitute investment contracts (and thus securities) and its contemporaneously released TurnKey Jet no action letter. (Click here for background in the article “SEC Staff Outlines Characteristics of Cryptoassets That Could Cause Them to Be Regarded as Securities” in the April 7, 2019 edition of Bridging the Week.)

According to Ms. Peirce, in endeavoring to help persons apply the four prongs of the so-called Howey test to determine whether particular cryptoassets might be deemed securities, Commission staff listed 38 distinct considerations “many of which include several sub-points.” (Click here to access a copy of the Supreme Court’s 1946 decision in SEC v. W.J. Howey Co.) Although she observed that “seasoned” securities attorneys might be able to successfully navigate this Scylla and Charybdis of staff guidance, she feared that non-lawyers likely could not.

Moreover, Ms. Peirce argued that the cryptoassets at issue in TurnKey Jet “so clearly did not [constitute] an offer of securities,” that discussion of the multitude of characteristics that prompted staff to conclude that the digital tokens were not securities “could have the effect of broadening the perceived reach of our securities laws.”

Ms. Peirce cautioned that the SEC’s “Jackson Pollock approach to splashing lots of factors on the canvas without any clear message leaves something to be desired.”

  • Defendant Convicted of Securities Fraud in Connection With Cryptosecurity Offer and Sales Asks for Leniency in Sentencing: Maksim Zaslavskiy, who previously pleaded guilty to conspiracy to commit securities fraud, requested the federal court in Brooklyn, New York, hearing his case to sentence him solely to probation. 

Mr. Zaslavskiy was charged in October 2017 with securities fraud and related offenses in connection with two cryptocurrency investment schemes and their related initial coin offerings. In September 2018, the same court rejected Mr. Zaslavskiy’s motion to dismiss his criminal charges on the grounds that he was not involved in the sale of securities; the court held that the government’s complaint alleged sufficient facts demonstrating that the relevant cryptoassets were investment contracts under applicable legal precedent (i.e., (1) an investment of money, (2) in a common enterprise with (3) the expectation of profits (4) solely from the efforts of a promoter or third party).

In his sentencing memorandum to the court, Mr. Zaslavskiy requested probation on the grounds that he has remitted all funds he received from customers in connection with his initial coin offerings except for funds automatically taken by Amazon to pay for advertising for the relevant cryptoassets. (Click here for background regarding Mr. Zaslavskiy’s criminal and SEC civil actions in the article “Brooklyn Federal Court Rules ICO-Issued Digital Assets Could Be Securities” in the September 16, 2018 edition of Bridging the Week.) The government will respond to Mr. Zaslavskiy's sentencing memorandum by May 15.

Compliance Weeds: FinCEN’s guidance fairly attempts to provide practical guidance to help persons engaging in businesses touching CVC to understand better whether they may have to register as an MSB. However, the guidance leaves uncertain a few important matters.

Generally, persons engaged as money transmitters of CVC must register as MSBs with FinCEN. However, this requirement does not apply to persons “functionally regulated or examined” by the Securities and Exchange Commission or the Commodity Futures Trading Commission. However, it is not clear what the word “functionally” references. In the case of the CFTC, all registrants and persons required to be registered are overseen and potentially examined by the Commission. Moreover, regarding virtual currencies, “[t]he CFTC’s jurisdiction is implicated when a virtual currency is used in a derivatives contract, or if there is fraud or manipulation involving a virtual currency traded in interstate commerce.” However, the CFTC has made clear that it does not “oversee ‘spot’ or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage, or financing.” (Click here to access the CFTC’s LabCFTC’s 2017 primer on virtual currencies; click here to access NFA Interpretive Notice 9073 regarding disclosure requirements for National Futures Association members engaging in virtual currency activities.) The new FinCEN advisory is silent as to FinCEN’s view of the meaning of “functionally” in the context of the CFTC's position.

Similarly, in a prior guidance, FinCEN made clear that a company purchasing and selling virtual currency, including paying and receiving the like amount of fiat currency to and from counterparties, for its own account, is not engaged in a money transmitter business. (Click here to access FIN-2014-R002.) This would seem to preclude a dealer of CVC from having to register as an MSB. However, the same prior guidance notes that if a firm were to provide services to others as a business that involved accepting and transmitting CVC or exchanging CVC for fiat currency or another CVC, “additional analysis would be necessary to determine the Company’s regulatory status and obligations with respect to such activity.” This distinction presents a blurry line that is treacherous to navigate. The new FinCEN guidance, particularly its discussion of P2P exchanges, provides no focus regarding this distinction, and the addressing of this topic solely by dropping a footnote referencing FinCEN’s prior guidance (see fn 52) does not advance certainty.

Finally, it is important that issuers and intermediaries of stablecoins review this new FinCEN guidance. In it, FinCEN makes clear that money transmission could include “the issuance and subsequent acceptance and transmission of a digital token that evidenced ownership of a certain amount of a commodity, security or futures contract” that serves as a substitute for fiat currency. Curiously, FinCEN also writes that money transmission may occur when a person who is not exempt from MSB status “issues or employs commodities, securities or futures contracts by themselves as value that substitutes for currency in money transmission services.” The meaning of this phrase in the context of SEC and CFTC registration requirements is unclear.

Importantly the triggers for registration as an MSB with FinCEN are parallel to the triggers for registration as a money transmitter (or something equivalent) in most states. However there is no uniformity among states’ requirements.