The recent boom in initial coin offerings has drawn wide-ranging regulatory scrutiny in the U.S. stemming from concerns that main-street investors are at increased risk of exposure to fraud when investing in unregistered ICOs. While the U.S. Securities and Exchange Commission, the U.S. Department of Justice, and other regulators have begun to weigh in on the risks associated with ICOs, it largely remains to be seen how regulators will address the international risks associated with digital currency transactions that often span international borders. For example, criminals may utilize cryptocurrency platforms to launder the proceeds of cross-border crimes with increasing anonymity and complexity, to make illegal payments to foreign officials in exchange for favorable treatment, or to invest in state-sponsored digital currencies offered by nations sanctioned by the U.S. government. For these reasons, individuals and businesses should carefully consider the potential civil and criminal penalties that could soon become a core focus of regulatory enforcement in the digital currency space, particularly in the areas of anti-corruption, anti-money laundering and economic sanctions violations.
Digital Currencies and Money Laundering
The U.S. government has implemented a number of laws, rules and regulations aimed at preventing individuals and criminal organizations from using the transfer of funds to launder the proceeds of their criminal conduct. These anti-money laundering laws have typically focused on tracing funds through complex fund transfers, often involving numerous offshore financial institutions, a variety of individuals, and shell companies. U.S. regulators and prosecutors are certain to concentrate increasingly on criminal schemes relying on the highly distributed nature of cryptocurrency trading platforms, especially given the anonymity involved in a wide range of digital currency transactions and the lack of cohesive regulatory oversight in the cryptocurrency space to date.
A 2017 enforcement action brought by the Financial Crimes Enforcement Network of the U.S. Treasury Department highlighted this focus. The matter of BTC-E aka Canton Business Corp. and Alexander Vinnik focused on BTC-e, a cryptocurrency “exchanger” platform operated in part by Alexander Vinnik.1 There, the “exchanger” platform enabled customers to buy and sell virtual currency in exchange for numerous forms of official currency or other virtual currencies.
After an investigation into the company’s activity, including involvement by the FBI, FinCEN determined that BTC-e had violated the Bank Secrecy Act by failing “to develop, implement, and maintain an effective written AML program that [was] reasonably designed to prevent the [money services business] from being used to facilitate money laundering and the financing of terrorist activities.”2 FinCEN also found that BTC-e, Vinnik and other company leadership “attracted and maintained a customer base that consisted largely of criminals who desired to conceal proceeds from crimes such as ransomware, fraud, identity theft, tax refund fraud schemes, public corruption, and drug trafficking.”3
FinCEN imposed a $110 million civil monetary penalty against BTC-e, classifying it as a money services business, or MSB, operating abroad, and finding that it willfully violated U.S. AML laws. It also imposed a $12 million civil penalty against Vinnik personally for his role in the violations. FinCEN’s action came hand in hand with an indictment by the U.S. Attorney’s Office for the Northern District of California, which alleges that Vinnik had violated 18 U.S.C. §§ 1956, 1957, and 1960 based substantially on the same conduct relating to the “exchanger” platform.4 BTC-e’s website subsequently was shut down after U.S. regulators seized the domain name.
The BTC-e case demonstrates how cryptocurrency platforms can easily lend themselves to criminal money laundering schemes. The case also illustrates that foreign-based MSBs may be required to comply with the BSA and Patriot Act regime if they conduct a sufficient volume of transactions within the United States. Moreover, the case represents a regulatory acknowledgment that active criminal conduct is not the only channel through which law enforcement authorities can pursue potential AML violations associated with operating a digital currency platform. Indeed, the case demonstrates that owners and operators of such platforms, even those platforms that are otherwise fully legitimate and compliant with relevant laws, may be subject to penalties for failing to implement and properly maintain adequate controls to prevent misuse of their services by criminals.
Anti-Corruption and State-Sponsored ICOs
In addition to the potential focus on rooting out money laundering schemes, regulators may also soon turn their attention to the U.S. Foreign Corrupt Practices Act as a tool for prosecuting individuals and companies that make unlawful foreign payments to government officials in the form of various digital currencies. In general, the FCPA renders illegal any “payment, promise to pay, or authorization of the payment of any money, or offer, gift, promise to give, or authorization of the giving of anything of value to ... any foreign official,” in an effort to obtain or retain a business opportunity.5 Notably, the FCPA does not require that the payor know the actual identity of the proposed recipient, nor does it require that a corrupt payment succeed in its purpose. Moreover, the FCPA defines “foreign official” quite broadly, covering any “officer or employee of a foreign government or any department, agency, or instrumentality thereof, or of a public international organization, or any person acting in an official capacity for or on behalf of any such government or department, agency, or instrumentality, or for or on behalf of any such public international organization.”6
Historically, common FCPA scenarios have involved, for instance, bribes to public officials through intermediary “sham” contracts to avoid the effects of regulations, taxes and fees associated with conducting business in another country.7 However, with the dawn of state-sponsored cryptocurrency platforms, the potential for foreign corrupt practices could expand substantially. For instance, Russia, Venezuela and China are all in the process of planning or exploring the introduction of government-backed digital currencies. One of the most notable and recent examples of a state-sponsored ICO came on Feb. 27, 2018, when the government of the Marshall Islands announced a Parliament-approved plan to issue its own sovereign cryptocurrency.8 The cryptocurrency, called sovereign or SOV, will be circulated as legal tender aside the U.S. dollar. The currency will be issued through an ICO, with supply capped at 24 million tokens to prevent inflation. Timing for the ICO has not yet been detailed, but SOV tokens will reportedly be made available to investors through a presale process. In addition, a number of cities have also expressed interest in developing digital currencies. For example, it has been reported that the government of Dubai recently revealed plans to launch what many have referred to as the first state-sponsored cryptocurrency, a digital token known as “emCash.”9 Other cities have also turned to city-sponsored ICOs as a way of efficient fundraising for municipal projects.10
Although it is unclear how these and similar platforms will be regulated, past experience suggests the increased use of digital currencies could pose a number of FCPA-oriented questions and risks. First, and perhaps most obviously, individuals and companies may use digital currencies to facilitate unlawful payments to foreign officials, particularly given the anonymity associated with them and the lack of centralized oversight and control. Second, as participation in some state-sponsored ICOs could be capped, such as in the case of the Marshall Islands’ pending ICO, this could create incentives for improper payments to foreign officials for early access to coin offerings.
In addition to these risks, some key questions remain as to the efficacy of affirmative defenses that might be asserted by a defendant in the context of an FCPA criminal investigation involving digital currencies. In particular, the FCPA provides an affirmative defense for payments that are legal under local law; however, court decisions have interpreted this defense narrowly.11 Moreover, given the distributed nature of cryptocurrency transactions, key questions remain as to which local laws, if any, would apply to support this affirmative defense. These gray areas highlight the extreme uncertainty associated with digital currencies and may countenance against hasty participation by individuals and businesses in state-sponsored ICOs.
A View From OFAC on Digital Currencies and Potential Sanctions Violations
The U.S. Treasury Department’s Office of Foreign Assets Control also has begun to weigh in on the application of U.S. economic sanctions to digital currency transactions. For example, in March 2018, OFAC issued guidance clarifying that U.S. sanctions apply to digital currency transactions.12 In addition, the U.S. government has specifically prohibited U.S. persons from engaging in certain transactions related to Venezuelan state-sponsored cryptocurrencies, as detailed below
In December 2017, Venezuelan President Nicolas Maduro announced plans for the government of Venezuela to launch a state-sponsored cryptocurrency called the “petro” or “petromoneda.”13 After reports indicated that the state-sponsored digital currency could potentially carry rights to commodities at a later date, questions arose with respect to whether investing in Venezuela’s state-sponsored cryptocurrency, ostensibly as form of debtor-creditor rights, could run afoul of Executive Order 13808,14 which imposed new sanctions targeting the government of Venezuela in regard to certain debt and equity financing arrangements. In response to this question, OFAC published a FAQ in January 2018 stating that “[a] currency with these characteristics would appear to be an extension of credit to the Venezuelan government. Executive Order 13808 prohibits U.S. persons from extending or otherwise dealing in new debt with a maturity of greater than 30 days of the Government of Venezuela. U.S. persons that deal in the prospective Venezuelan digital currency may be exposed to U.S. sanctions risk.”15
Subsequently, in March 2018, President Donald Trump signed an executive order barring “[a]ll transactions related to, provision of financing for, and other dealings in, by a United States person or within the United States, any digital currency, digital coin, or digital token, that was issued by, for, or on behalf of the Government of Venezuela on or after January 9, 2018.”16 The U.S. government’s response to Venezuela’s introduction of the petro could be telling of future measures to prevent U.S. investment in digital currencies sponsored by sanctioned countries.
In addition, given the anonymity of many digital currency transactions, there is risk that U.S. persons may inadvertently engage in transactions involving individuals or entities targeted by list-based sanctions. Currently, there is no effective way to perform restricted-party screening of counterparties to most digital currency transactions. While OFAC is exploring options to add digital currency addresses to the specially designated nationals list, OFAC’s collection of addresses is nonexhaustive, and digital currency users can easily use a new address for every transaction, depending on the platform. In light of these risks, U.S. persons should proceed with caution, and conduct appropriate screening of prospective counterparties to digital currency transactions to avoid inadvertent violations of U.S. sanctions.
The sanctions risks presented by digital currency transactions appear primed to increase, as the governments of certain countries currently targeted by U.S. sanctions (including Russia and Iran) reportedly are exploring the development of new digital currencies. For example, Russia has indicated its interest in creating a state-sponsored digital currency, a “cryptorouble,” presenting the potential for avoiding the numerous sanctions imposed by the U.S. and other countries in recent months.17
As digital currencies continue to evolve on the international platform, the anonymous and decentralized nature of the cryptocurrency transactions could present a number of potential violations of U.S. anti-corruption, sanctions and anti-money laundering laws. Therefore, companies are well-advised to develop, implement and maintain thorough compliance policies and procedures that take into account the potential for these abuses, emphasizing the potentially severe consequences of even minor violations by employees. Moreover, businesses should conduct careful and thorough due diligence before making or accepting digital currency payments to or from companies located in high-risk countries, or before investing in certain state-sponsored ICOs, particularly those offered by countries at risk of being targeted by U.S. sanctions.