InfoBytes Blog
Filter
Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.
New York DFS Superintendent Lawsky Comments On Virtual Currency and Bitcoin Regulation
On October 14, Superintendent Lawsky delivered remarks on virtual currency and Bitcoin regulation in New York City. Specifically, Lawsky addressed the comments received in connection with the DFS’s July 17 proposal to establish a licensing regime for virtual currency businesses. Lawsky clarified the following five areas of concern: (i) who will be required to obtain a BitLicense; (ii) which type of license, money transmitter and/or virtual currency, a business will be required to obtain, confirming that, if both are required, the application process will be streamlined; (iii) the requirements that banks providing virtual currency services will need to comply with; (iv) the regulation of mining when a miner engages in virtual currency services; and (v) the “compliance costs of regulation on new or fledging virtual currency enterprises.” Noting that the DFS hopes that companies will work with the DFS as opposed to “run[ning] from regulation,” Lawsky emphasized the significance of appropriate regulation as it pertains to safeguarding customers’ money at financial companies.
Digital Insights and Trends: Can Bitcoin Support Money Laundering Charges?
Updated Oct. 7, 2014
Bitcoin owners and exchange operators are coming face-to-face with prosecutors focused on money laundering crimes, leading to novel legal arguments about whether the virtual currency is money, or sufficiently “money-like” to support charges of money laundering and other financial crimes. This comes in contrast to a determination by the IRS, for one, stating that virtual currency such as Bitcoin is treated as property for federal tax purposes, and by FinCEN and FATF, that it does not have all the attributes of real currency and does not have legal tender status. Within this context, FinCEN's Director Jennifer Shasky Calvery recently told Coindesk that the agency is focused on the bad actors, and not the new technology itself.
As reported last month in Digital Commerce & Payments, a New York Federal District Court concluded in Faiella et al. v. United States, that Bitcoin is “money,” denying a defendant’s motion to dismiss a money laundering charge. The defendant was charged with unlawfully operating an unlicensed money transmitting business, but unsuccessfully tried to dismiss the charge because Bitcoin is not “money.” The court said Bitcoin “clearly qualifies as ‘money’,” as it “can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.”
Another case in a Federal District Court in Texas, involves a defendant, Trendon Shavers, who argued that he didn’t violate federal securities laws because his Bitcoin investors didn’t invest in “securities”, that his transactions were all denominated in Bitcoin, and that real money did not exchange hands. The SEC took the position that the Bitcoin investments were both investment contracts and notes, and therefore, securities. Although relevant securities law says a security involves an investment of money, the court said Bitcoin could be “used as money,” “used to purchase goods or services,” and “used to pay for individual living expenses.” It can also be exchanged for money. The court’s conclusion: “Bitcoin is a currency or form of money.”
Down in Miami, Florida, Bitcoin sellers Pascal Reid and Michel Espinoza were charged in February with money laundering after selling Bitcoin to undercover police officers to whom they admitted using Bitcoin to buy stolen credit card numbers. Defense counsel said his client couldn’t have been money laundering because Bitcoin isn’t money, but a Miami-Dade Circuit Court judge said Florida can prosecute “trade-based money laundering.” Rather than argue whether Bitcoin is money, the judge looked to the currency paid to buy the Bitcoin – and said that’s what was being laundered. The case involving Ross Ulbricht is reaching similar conclusions.
The race to define Bitcoin continues, but early indications point to a predictable conclusion: Bitcoin’s controversial status isn’t going to help its owners or traders avoid prosecution for financial crimes.
New York Extends Comment Period For BitLicense Proposal
This week, the New York DFS announced the extension of the comment period on its proposal to create a regulatory licensing framework for virtual currency companies, including a so-called BitLicense. Given the “significant amount of public interest in and commentary on” the proposal, the DFS doubled the length of the comment period from 45 to 90 days. Comments are now due by October 21, 2014. Further information about the proposal and related issues is available here.
CFPB Announces Two Actions Related To Virtual Currencies
On August 11, the Consumer Financial Protection Bureau (the CFPB or Bureau) issued a "consumer advisory" concerning virtual currency and also announced that it would begin accepting consumer complaints about virtual currency or virtual currency companies. These actions are the consumer agency’s first foray into virtual currencies, and they follow a recent GAO report that recommended the CFPB play a larger role in the development of federal virtual currency policy.
Consumer Advisory
The advisory describes virtual currencies, briefly notes their potential for innovation, and cautions consumers about the numerous and significant risks the CFPB believes virtual currencies present for consumers. Specifically, the CFPB cautions virtual currency consumers that there are risks related to hackers, fewer consumer protections, costs, and scams. The advisory elaborates on the risks for each stage of a virtual currency transaction: purchasing, storing, or transacting in virtual currencies. For example:
- Purchasing: Warns consumers purchasing virtual currencies to beware of cost fluctuations and potential scams.
- Storage: Expresses concerns about data security risks and the lack of federal insurance for virtual currencies.
- Transactions: Advises consumers transacting in virtual currencies to read their agreement with their wallet provider and be mindful of the risks of linking their digital wallet account to their bank account or payment card.
Consumer Complaints
The Bureau announced that it is working on a new form for virtual currency complaints, but in the meantime will accept such complaints using its money transfer complaints form.
Virtual currency complaints will be subject to the CFPB’s standard complaint process. As described in the CFPB’s most recent consumer complaint report, once a complaint is submitted, the CFPB sends the complaint to the appropriate company and works with the company to get a response within 15 calendar days. Each complaint is published in a public database after the company responds to the complaint or after the company has had the complaint for 15 days, whichever comes first. If a company can demonstrate within the 15-day period that it has been wrongly identified, no data for that complaint will be posted unless and until the correct company is identified. The CFPB states that if it receives a complaint about an issue outside its jurisdiction, the Bureau will forward the complaint to the appropriate federal or state regulator.
Jurisdictional issues notwithstanding, the Bureau promises to use all virtual currency complaints it receives to better understand the virtual currency market and its effect on consumers. The CFPB also asserts that it will use complaints to help enforce federal consumer financial laws and, if appropriate, take consumer protection policy steps. The Bureau has demonstrated through its examination and enforcement activity in other areas that consumer complaints play a significant role in the Bureau’s risk-based approach to supervision and enforcement. Moreover, the CFPB recently proposed to publish consumer complaint narratives with other complaint data already made public, noting in its proposal that by increasing consumer complaint volume, publication of narratives would benefit “the many Bureau functions that rely, in part, on complaint data to perform their respective missions including the Offices of Supervision, Enforcement, and Fair Lending, Consumer Education and Engagement, and Research, Markets, and Rulemaking."
* * *
Our Digital Commerce & Payments Practice group is experienced in regulatory matters arising at the intersection of digital payments, financial institutions, and technology providers, and is uniquely positioned to assist virtual currency and related companies whose business brings them into contact with the CFPB.
Our Consumer Financial Protection Bureau group has advised clients in dozens of CFPB examinations, investigations, and enforcement actions and frequently represents clients in connection with CFPB supervision preparedness and matters pertaining to compliance with CFPB rulemakings and regulatory expectations, including consumer complaint issues.
Please contact one of the attorneys listed below if you would like to discuss the CFPB advisory or complaints announcement.
- Manley Williams, (202) 349-8060
New York Virtual Currency Proposal Could Capture Bank Products, Card Rewards Programs
On July 17, the New York Department of Financial Services (NYDFS) proposed a rule intended to govern the virtual currency marketplace. The proposed rule is extremely broad and as currently drafted would appear to capture products provided by traditional brick and mortar banks and other regulated financial institutions. For example, as proposed, the rule could regulate:
- Reward programs, "thank you" offers, or digital coupons that offer cash back or statement credits;
- Generated numbers that access cash;
- Prepaid access and other cards that will allow customers to receive cash, including those customarily exempt such as government funded transfers;
- P2P transfers; and
- Wallet providers where the customer can access cash.
If left unaddressed, these apparent unintended consequences could create a confusing regulatory environment for certain bank and card products. It is also noteworthy that the rule does not provide any customary exclusions for chartered entities, raising substantial preemption questions.
Businesses engaging in activities covered by the proposed rule would be required to apply for a license from the NYDFS within 45 days of the effective date of the regulation. The proposed rule also sets out comprehensive compliance obligations involving consumer protection, cybersecurity, anti-money laundering, and anti-fraud, and the rule would subject licensed institutions to examination by the NYDFS. Failure to obtain a license could result in disciplinary action by the NYDFS.
The comment period on the proposed rule ends on September 6, 2014.
* * *
Our Digital Commerce & Payments Practice group is experienced in regulatory matters arising at the intersection of digital payments, financial institutions, and technology providers, and is uniquely positioned to assist virtual currency and related companies whose business brings them into contact with the CFPB and/or the NYDFS.
Please contact one of the attorneys listed below if you would like to discuss the scope of the obligations set forth in the NYDFS proposed rule.
- Manley Williams, (202) 349-8060
Digital Insights & Trends: Will NY's BitLicense Stifle an Industry (or Just Relocate it)?
The New York Department of Financial Services riveted the attention of the virtual currency world (and just about everyone else involved with digital financial services), with its July 17 proposal to issue licenses for Virtual Currency Business Activities. The so-called BitLicense proposal features broad coverage; open ended capital and bonding requirements; personal investigation of founders, investors and even employees; and prior regulatory approval of new products and activities.
These and other aspects of BitLicensing beg the question: will licensing protect the public and investors? Or just drive Bitcoin participants out? (If they leave, they may find roadblocks elsewhere; days before New York’s announcement, France’s Ministry for the Economy and Finance, for example, proposed regulating Bitcoin.) Opportunistic locales for virtual currency operators are already being identified, such as the Isle of Man, a self-governing British Crown Dependency, whose Financial Supervision Commission says it is “not the appropriate time” to introduce a regulatory regime, while warning there is no consumer protection in the digital currency market. Think about this: Tiny Delaware is a corporate legal haven, Switzerland created an international bank haven, and a virtual currency haven may be next. Regulatory exercises like New York’s could advance that option.
Founders of virtual currency startups (as well as other more traditional emerging payment businesses generally) aren’t keen to disclose personal financial information and fingerprints, and aspects of the NY bitlicensing rule such as the requirement to keep consumer complaints on file for 10 years, and limitations on permissible investments for licensees’ retained earnings have created a torrent of online backlash. BitLicensees could not introduce new products or materially change their activities without approval of the NY superintendent of financial services, with no timeline for approval. Prior approval of business activities in this fast-paced industry troubles high-tech innovators, who worry that their products aren’t well understood. The anticipated cost of the NY BitLicense, regulatory compliance programs, and required audit and reporting are also perceived as dampers on a fledgling industry.
Despite new regulatory proposals, the virtual currency industry is gaining ground, as evidenced by groups including the North American Bitcoin Conference (NABC), UK Digital Currency Association, Bitcoin France Bureau, Bitcoin Association of Australia, Australian Digital Currency Commerce Association and the newly formed Chamber of Digital Commerce. First stop is lobbying in Washington, with demands for “smart regulation,” followed by media outreach by the industry’s public affairs people.
Virtual currencies will eventually be regulated, because AML and worldwide counter-terrorism priorities demand it, but I’m not sure BitLicenses will prevent Mt. Gox-like meltdowns. We represent clients in many financial services industries, and despite elaborate licensing rules, investors lose money, providers lose traction, and things go wrong occasionally. Requirements for managing electronic data and transaction risk didn’t prevent breaches at Target or Neiman Marcus, despite their robust (and expensive) systems. Outsized regulatory reporting requirements increase costs, which startups are keen to control. Moreover, realigning limited regulatory resources toward virtual currency regulation could mean less oversight of other, also important controls, with unhappy consequences. New York is trying to strike the right balance between creating a regulatory structure to aid in the legitimacy of the new medium while not stifling its growth or pushing it to friendlier regulatory environments. However, is it too much too soon?
New FinCEN SAR Summary Report Discusses Bitcoin-Related Filings
On July 18, FinCEN published SAR Stats—formerly called By the Numbers—an annual compilation of numerical data gathered from the Suspicious Activity Reports (SARs) filed by financial institutions using FinCEN’s new unified SAR form and e-filing process. Among other things, the new form and process were designed to allow FinCEN to collect more detailed information on types of suspicious activity. As such, FinCEN describes the data presented in this first SAR Stats issue as “a new baseline for financial sector reporting on suspicious activity.” The primary purpose of the report is to provide a statistical overview of suspicious activity developments, including by presenting SAR data arranged by filing industry type for the more than 1.3 million unique SARs filed between March 1, 2012 and December 31, 2013. In addition, the redesigned annual publication includes a new SAR Narrative Spotlight, which focuses on “perceived key emerging activity trends derived from analysis of SAR narratives.” The inaugural Spotlight examines the emerging trend of Bitcoin related activities within SAR narrative data. It states that FinCEN is observing a rise in the number of SARs flagging virtual currencies as a component of suspicious activity, and provides for potential SAR filers an explanation of virtual currencies and the importance of SAR data in assessing virtual currency transactions.
New York Proposes First Virtual Currency Licensing Framework
On July 17, the New York DFS announced a proposal to establish a licensing regime for virtual currency businesses, the first by any state. In January, the DFS held a two-day hearing on developing a regulatory framework for virtual currency firms, and subsequently sought applications for virtual currency exchanges pending completion of the regulations. The proposed regulations define virtual currency as “any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology.” This would include digital units of exchange that: (i) have a centralized repository or administrator; (ii) are decentralized and have no centralized repository or administrator; or (iii) may be created or obtained by computing or manufacturing effort. It would exclude digital units that are used solely within online gaming platforms or that are used exclusively as part of a customer affinity or rewards program.
Under the proposal, the state would require companies engaged in the following activities to obtain a so-called BitLicense: (i) receiving or transmitting virtual currency on behalf of consumers; (ii) securing, storing, or maintaining custody or control of such virtual currency on the behalf of customers; (iii) performing retail conversion services; (iv) buying and selling virtual currency as a customer business (as distinct from personal use); or (v) controlling, administering, or issuing a virtual currency. To obtain a license, a business would be required to, among other things: (i) hold virtual currency of the same type and amount as any virtual currency owed or obligated to a third party; (ii) provide transaction receipts with certain required information; (iii) comply with AML rules; (iv) maintain a cyber security program; and (v) establish business continuity and disaster recovery policies. Licensed entities would be subject to DFS supervision, with examinations taking place no less than once every two calendar years. The proposal will be published in the New York State Register’s July 23, 2014 edition, which begins a 45-day public comment period.
California Removes Statutory Restrictions On Virtual Currency
On June 28, California Governor Jerry Brown signed AB 129, which repeals a state ban on the issuance or circulation of anything but lawful money of the United States. As described in a legislative staff analysis of the bill, the repeal is designed to ensure that forms of alternative currency such as digital currency, points, coupons, or other objects of monetary value do not violate the law when those methods are used for the purchase of goods and services or the transmission of payments in California.
European Banking Authority Potential Virtual Currency Regulatory Responses
On July 4, the European Banking Authority (EBA) released an Opinion that outlines for the EU Council, the European Commission, and the European Parliament requirements that would be needed to regulate virtual currencies. The EBA identified more than 70 risks across several categories and numerous causal drivers for those risks, including that (i) a virtual currency scheme can be created, and then its function subsequently changed, by anyone, and in the case of decentralized schemes, by anyone with a sufficient share of computational power; (ii) payer and payee can remain anonymous; (iii) virtual currency schemes do not respect jurisdictional boundaries and may therefore undermine financial sanctions and seizure of assets; and (iv) market participants lack sound corporate governance arrangements. To address those drivers, the EBA believes a regulatory framework would need to comprise, among other elements: (i) governance requirements for certain market participants; (ii) segregation of client accounts; (iii) capital requirements; and (iv) the creation of “scheme governing authorities” accountable for the integrity of a virtual currency scheme and its key components, including its protocol and transaction ledge. Given that the creation of such a regulatory framework will take time, the EBA recommends that European national prudential regulators take action in the immediate term to discourage financial institutions from buying, holding or selling virtual currencies while no regulatory regime is in place. In addition, the EBA recommends that EU legislators consider declaring market participants at the direct interface between conventional and virtual currencies, such as virtual currency exchanges, to become “obliged entities” under the EU Anti Money Laundering Directive and thus subject to its anti-money laundering and counter terrorist financing requirements. The EBA report follows a recent reportby the inter-governmental Financial Action Task Force (FATF) that provides an overview of virtual currency terms, markets, risks, and law enforcement actions announced to date.