Key Takeaways

• The Joint Chiefs of Global Tax Enforcement (J5) issued its first intelligence bulletin providing guidance to banks, law enforcement partners and private investigators regarding indicators of potential misconduct related to non-fungible tokens (NFTs).
• The J5 report on NFTs and the U.S. Department of the Treasury’s February study underscore the time and attention that regulatory agencies are dedicating to NFTs and the potential fraud risks that market participants face.
• NFT market participants should know what to ask of potential partners and clients by implementing comprehensive compliance programs to comply with anti-money laundering and know-your-customer requirements and securities, commodities and tax rules and regulations.

Answering the call for guidance regarding potential issues concerning the popular cryptocurrency assets NFTs, on April 28, the J5 issued a first-of-its-kind intelligence bulletin warning the public of the dangers of dealing with NFTs. Titled the “J5 NFT Marketplace Red Flag Indicators,” the bulletin provides real-world guidance to banks, law enforcement partners and private investigators intended to help improve their fraud detection measures. The guidance is based on information obtained by members of the global task force and shared as part of its mission to prevent tax evasion. “This space is changing so fast, and technologies and products have the ability to become the ‘next big thing’ without any due diligence or regulation on the part of the creator of the product,” says Special Agent Oleg Pobereyko, J5 Crypto Group lead. “We tried to put together a product that would help keep people safe while law enforcement catches up to these particular concerns.” The J5 report on NFTs follows a study published by the Treasury Department in February highlighting the use of the NFT marketplace to facilitate money laundering and terrorist financing, underscoring the time and attention that regulatory agencies are dedicating to NFTs and the potential fraud risks that market participants face.

Some of the “strong” fraud indicators J5 listed include:

• A network of sending and receiving parties to the same transaction or group of transactions.
• Clearly overpriced/underpriced NFTs that are traded frequently in short time frames.
• Artificially increasing sale value through a series of trades between linked accounts, known as “wash trading.”
• Newly minted NFTs sold at high price points immediately that are not in line with other NFTs in the collection.
• NFTs sold for large sums and reacquired from the same party or a third party for smaller amounts.

Jim Lee, chief of IRS Criminal Investigation, hopes “this is the first of several of these intelligence bulletins the J5 puts out ... [the J5 is] doing incredibly innovative things ... and the lessons we are learning are cutting edge. Sharing that information with the public and private sectors can only help stop various types of fraud before they become the next case in our investigative inventory.”

Now that the J5 has issued clear guidance to those in the virtual currency industry, it will be critical that those involved with NFTs respond to this bulletin by incorporating the guidance into their compliance policies and due diligence. Specifically, businesses would be well advised to establish comprehensive compliance programs aimed at ensuring that those with whom they do business are following all applicable laws, including anti-money laundering and know-your-customer requirements and securities, commodities and tax rules and regulations. In addition, some companies in the industry are required to register as money services businesses. Employing best practices by knowing what to ask of whom is key to adequate due diligence on potential partners and clients. While the digital asset space is known for its anonymity, sufficient compliance programs and due diligence require a “trust but verify” approach.

Next month, the J5 will hold its fourth iteration of “The Challenge,” a series of meetings during which members of each country (Australia, Canada, England, the Netherlands and the U.S.) will use analytical tools to generate leads and find tax offenders using cryptocurrency to globally evade tax laws.

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