Asset Seizures and Arrests Mark Recent Federal Virtual Currency Enforcement Actions
Federal authorities have initiated several recent enforcement actions that are indicative of continuing regulatory changes in the virtual currency industry. First, on May 14, 2013, the Department of Homeland Security initiated a seizure of the Dwolla account belonging to a leading Japanese-based Bitcoin exchange company, Mt. Gox, taking the position that Mt. Gox's U.S. subsidiary, Mutum Sigillum LLC, operated as an unlicensed money transmitter in violation of 18 U.S.C. § 1960. Second, a joint investigation conducted by the Department of Justice, the Secret Service, the Internal Revenue Service and Homeland Security ended with an indictment charging a Costa Rican company called Liberty Reserve with laundering more than $6 billion in the last seven years. Seven current and former company officials were also named in the indictment, five of whom have reportedly been arrested. These enforcement actions come in the wake of recent guidance from the Financial Crimes Enforcement Network (FinCEN) regarding the regulation of virtual currency (the Virtual Currency Guidance). Further, FinCEN's discussion of the Liberty Reserve indictment reveals its view of the historic case as related to both the operation of a web-based payment and money transfer system and the offering of a virtual currency. In light of the apparent conflation of "web-based money transfer system" with "virtual currency," individuals and companies involved with either type of program should take note of these developments.
The Enforcement Action Against Mt. Gox
While the Virtual Currency Guidance and law enforcement action relating to virtual currency are relatively new, the tools employed in the seizure of assets related to the Mt. Gox action are not. To effect the seizure, the U.S. government turned to long-standing statutory law, namely 18 U.S.C. § 1960, which declares that any person or entity that “knowingly conducts, controls, manages, supervises, directs, or owns” even part of an “unlicensed money transmitting business” is committing a felony, subject to a fine and five years’ imprisonment. 18 U.S.C. § 1960(a). The statute expressly provides that an “unlicensed money transmitting business” is one that “transfer[s] funds on behalf of the public by any and all means[,]” in a manner that “affects interstate or foreign commerce” in any way, and that operates in a state requiring a money transmitting license but does not have such a license, or fails to comply with registration requirements of 31 U.S.C. § 5330, or “otherwise involves the transportation or transmission of funds” derived from or intended to support criminal or unlawful activity. 18 U.S.C. § 1960(b)(1), (2). In short, if a money transmitter does not register with FinCEN, obtain licenses from the applicable state entities and comply with the federal anti-money-laundering regulations of the Bank Secrecy Act, the money transmitter is “unlicensed” and in violation of 18 U.S.C. § 1960.
At this early stage, although no criminal charges have been brought against Mt. Gox or its subsidiary Mutum Sigillum LLC, Mt. Gox, its subsidiaries and the financial institutions that hold their funds must now grapple with how to defend their assets under federal civil asset forfeiture laws. These laws, many of which have their roots in admiralty practice and require lawyers and parties to follow the rarely used Supplemental Rules for Admiralty or Maritime Claims, are rife with traps for the unwary, any of which could be fatal to attempts to defend and recover seized assets. Similarly for unlicensed money transmission, 18 U.S.C. § 981 specifically declares that "[a]ny property, real or personal, involved in a transaction in violation of section 18 U.S.C. § 1960" is "subject to forfeiture to the United States."
The Enforcement Action Against Liberty Reserve
Federal prosecutors indicted Liberty Reserve and arrested five of its principal corporate officers on charges of money laundering this week. The indictment charges Liberty Reserve and seven current and former corporate officers and employees with laundering more than $6 billion over seven years through its virtual currency exchange services, thereby facilitating “global criminal conduct.” Liberty Reserve, which is based in Costa Rica and was incorporated in 2006, offered an anonymous payment system, with low transaction fees (generally 1%,with a maximum of $2.99), through its proprietary gold-backed e-currency, LR. The investigation into Liberty Reserve involved law enforcement agencies in 17 countries, and the indictment may represent the largest international money-laundering prosecution in history. Notably, in connection with the indictment and arrests, law enforcement also seized five domain names and seized or restricted the activity of 45 bank accounts. Some of the seized assets belonged to third-party exchangers that interfaced with Liberty Reserve as a way to translate legal tender and other virtual currency into LR. According to The New York Times, the case is significant because of its size and scope, and also because it evidences intent of federal law enforcement to "attack the financial infrastructure utilized by many cybercriminals in much the same way that drug-money-laundering prosecutions unravel the financial underpinnings of the narcotics trade."
In addition to the size and scope of the operation, and the volume of money allegedly involved, the Liberty Reserve case is also historically significant because the Department of the Treasury invoked its powers under Section 311 of the USA Patriot Act, 31 U.S.C. § 5318A. On May 28, 2013, the director of FinCEN found that Liberty Reserve is a financial institution of primary money-laundering concern. This finding, in turn, enables FinCEN to require domestic financial institutions and financial agencies to take "special measures" against Liberty Reserve. To that end, FinCEN issued a notice of proposed rulemaking offering a rule that, if adopted, would prohibit covered financial institutions from "establishing, maintaining, administering, or managing in the United States" virtually any account "being used to process transactions involving Liberty Reserve, including any of its branches, offices or subsidiaries." The rule would further require covered institutions to implement additional due diligence and record-keeping measures designed to protect against processing any transactions involving Liberty Reserve. Section 311 actions are separate from actions instituted by the Department of the Treasury's Office of Foreign Assets Control and have been used sparingly since Section 311’s enactment. In fact, FinCEN has implemented special measures against just four jurisdictions and 13 financial institutions since 2002. Importantly, this is the first time FinCEN has used Section 311 against a virtual currency exchange.
Enforcement Actions Are Not Entirely Novel, Even in the Virtual Currency Space
If this pattern of prosecution and seizure activity sounds familiar, it should. Other high-profile enforcement actions against Internet-based companies like E-Gold, PokerStars and Neteller all included allegations relating to the unlawful transmission of monies. The U.S. government seized E-Gold and Neteller assets pursuant to the same statute: 18 U.S.C. § 1960. Further, just as the government targeted accounts held at small, out-of-the-way SunFirst Bank of St. George, Utah in the poker cases, the government has targeted assets at previously unheralded Veridian Credit Union of Waterloo, Iowa in relation to Mt. Gox. Finally, at least one of the individuals indicted in the Liberty Reserve case has a previous New York conviction for unlicensed money transmission relating to his prior operation of an E-Gold exchange. In other words, the use of Patriot Act Section 311 special measures may be novel in the virtual currency space, but the trend of greater regulatory enforcement is not.
Irrespective of the statutory authority used, the clear concern in both the prior and current enforcement actions is that the virtual currency system was designed, promoted and blatantly used as an anonymous payment system that facilitated criminal activity. E-Gold's indictment in 2008, for example, described the use of false names such as "Mickey Mouse" or "Donald Duck," such that it was clear that the company undertook no identity verification program as required by the Bank Secrecy Act and its implementing regulations. See, e.g., United States v. E-Gold, Ltd., CR-07-109 (D.D.C. 2008). Similarly, Liberty Reserve is alleged to have collected a name, address and date of birth from its users, but not verified the information, such that, practically, a user needed to provide only an email address to use the payment system. Although these are extreme examples, as law enforcement places greater emphasis on transfers using virtual currency, untangling how federal and state regulations apply to each program becomes increasingly imperative.
Importance of These Enforcement Actions
These enforcement actions and the recent FinCEN Virtual Currency Guidance indicate that the government is turning its attention to applying long-standing, wide-ranging and hard-to-interpret money services business laws and regulations to virtual currency businesses. In light of the complicated legal landscape and the high stakes involved with noncompliance, whether intentional or unintentional, individuals and companies connected to the virtual currency ecosystem should promptly seek guidance as to whether they might be considered “money transmitters” that are required to be registered federally and/or licensed at the state level. Unfortunately, there is no easy answer, as the analysis is highly fact-sensitive. Proper analysis of a company’s specific business model is necessary to properly apply federal registration and state licensure requirements—slight differences in operations may determine whether an entity is a “money transmitter” or whether an exemption applies.