Why it matters
The rapid evolution of virtual and digital currencies has spawned significant activity in several federal agencies with implications potentially for traditional entities in certain cases. In addition to reported actions by the Securities and Exchange Commission and a proposed regulation by The Bureau of Consumer Financial Protection (CFPB), two rulings issued by the Financial Crimes Enforcement Network (FinCEN) as part of its effort to provide greater clarity to digital and virtual currency-related companies, may also portend a tightening of a money services business (MSB) exemption frequently relied on by traditional payment processors.
In the two most recent rulings by FinCEN, agency staff refused to provide relief to two companies that had argued they were not money transmitters and thus did not fall under the Bank Secrecy Act’s (BSA) definition of a “money service business.” FinCEN staff noted that, as a result, both will be subject to the full range of reporting, recordkeeping and other obligations imposed by the BSA on MSBs.
Most startling to the Bitcoin community was the conclusion of FinCEN staff that an exchanger was an MSB regardless of whether it acted as a broker (i.e., “attempting to match two (mostly) simultaneous and offsetting transactions involving the acceptance of one type of currency and the transmission of another”) or as a dealer (i.e., “transacting from its own reserve in either convertible virtual currency or real currency”). While FinCEN has not yet determined that crypto-to-crypto currency exchanges are money transmission activities, these orders may be a step in that direction.
One company sought to provide virtual currency payments to merchants in both the United States and Latin America who wish to receive customer payments in Bitcoin; the other proposed to match offers to buy and sell legal or “real” currency for virtual currency. In each case, the company argued that it was a payment processor that was exempt from the definition of money transmitter. FinCEN determined that neither qualified for the exemption because neither processed payments between two regulated financial institutions and that each was required to register as an MSB and comply with the BSA’s recordkeeping, reporting and Anti-Money Laundering (AML) compliance program requirements.
Detailed discussion
The company that planned to set up a platform consisting of a trading system to match offers to buy and sell convertible virtual currency for currency of “legal tender” as well as a set of book accounts where prospective buyers or sellers of one type of currency could deposit funds to cover their exchanges said it would maintain separate accounts in U.S. dollars as well as a virtual wallet from which customers could make either USD or virtual currency deposits to fund their exchanges. In both cases, the accounts and the wallet would be segregated and protected from potential seizure by the company’s creditors.
Analogizing the business to a securities or commodities exchange, the company argued that it should not be considered a money transmitter because no money transmission occurred between the company and any counterparty. Alternatively, it argued that the money transmission would be integral to the company’s business or otherwise eligible for the payment processor exemption. And, finally, it argued that it should be characterized as a “user” rather than “exchanger” or “administrator” of virtual currency pursuant to FinCEN’s 2013 guidance determining the former was not an MSB.
FinCEN staff rejected all three arguments. The business clearly includes a money transmission even though transactions occur subject to the condition of finding a match, Jamal El-Hindi, Associate Director of the Policy Division at FinCEN, wrote in FIN-2014-R011. “The regulatory definition of money transmission does not contain any element of conditionality before it applies,” he said. “A person that accepts currency, funds, or any value that substitutes for currency, with the intent and/or effect of transmitting currency, funds, or any value that substitutes for currency to another person or location if a certain predetermined condition established by the transmitter is met, is a money transmitter under FinCEN’s regulations.” According to the letter, two money transmitter transactions occur in this model one between the company and the customer selling the virtual currency and one between the company and customer buying the virtual currency.
El-Hindi also rejected the claim that the money transmissions were integral to the transaction and similarly that the transmissions qualified for the payment processor exemption. He concluded that the payment service met the definition of a money transmission because the company “is facilitating the transfer of value, both real and virtual, between third parties. Such money transmission is the sole purpose of the company’s system, and is not a necessary part of another, non-money transmission service being provided by the company.”
As to the payment processor exemption, he said the company failed to meet two of its requirements: the company is not receiving payment as a seller or creditor from a buyer or debtor for the provision of a non-money transmission-related good or service, noting that providing virtual for real currency or vice versa is not a non-money transmission-related service, and by making payments of convertible virtual currency directly to and from customers, the company is not operating through a clearing and settlement service that admits only BSA-regulated financial institutions as members.
Further, the letter states the company could not be considered a “user” of virtual currency pursuant to FinCEN’s 2013 guidance because it intended to accept convertible virtual currency from one person and transmit it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency. It said, “Whether a person is deemed to be an MSB depends on how that person uses the convertible virtual currency, and for whose benefit.”
In the second ruling, FIN-2014-R012, El-Hindi reached a similar conclusion with regard to a business that intended to provide virtual currency-based payments to Latin American hotels. Customers would pay for their purchase using a credit card, which would be transferred to the company. The company would then transfer the equivalent in Bitcoin to the merchant.
Although the company would purchase and store Bitcoin to use for payments to the merchant, the “fact that the company uses its cache of Bitcoin to pay the merchant is not relevant,” according to the ruling. Because the company plans to accept and convert the customer’s real currency into virtual currency for transmission to the merchant, it was an exchanger pursuant to FinCEN’s guidance and therefore a money transmitter.
Like the first company, the payment processor exemption did not apply as the company did not plan to operate through clearing and settlement systems that admit only BSA-regulated financial institutions, El-Hindi wrote.
To read FIN-2014-R011, click here.
To read FIN-2014-R012, click here.
SEC Strikes Out After Bitcoin Companies
Sending shivers through the Bitcoin community, the Securities and Exchange Commission (SEC) reportedly has sent the first of many letters expected to be sent to crypto currency-related companies asking them informally to submit information to assist the SEC in determining whether violations of federal securities laws have occurred.
Redacted letters available on the Internet do not specify the nature of the violations at issue (widely expected to include the public sale of unregistered securities via crowd funding and Ponzi schemes). However, they request the companies to produce a significant amount of information. While companies receiving such letters are not required by law to respond, the failure to cooperate may be viewed unfavorably if the SEC determines a violation has occurred. The cost of producing the requested documents may prove costly for those receiving the letter even if a determination is made ultimately that no violation has occurred.
Plaintiff’s Attorney Attacks Bitcoin-Related Companies
A crypto currency exchange customer has sued a Florida company providing crypto-to-crypto exchange, alleging, among other things, that his crypto currency holdings were stolen as a result of a weakness in the exchange platform’s data security protocol. The company had denied the allegations, asserting instead that the customer failed to take appropriate precautions to protect his crypto currency. This lawsuit appears to signal an increased focus by the plaintiff’s bar on companies in the crypto currency industry, putting pressure on a fledgling industry to address data security, consumer disclosures and other practices that could subject them to costly allegations of unfair, deceptive or abusive acts and practices, fraud and other allegations favored in actions brought by the plaintiff’s bar.
CFPB Has Virtual Currencies in Its Sights With Prepaid Access Proposal
The Bureau of Consumer Financial Protection (CFPB) has released its long-awaited proposal to extend Regulation E and Regulation Z protections to prepaid access. In the 870-page release, one paragraph discusses virtual currency. Noting that the CFPB began accepting complaints on virtual currency in August 2014, the proposal says: “The Bureau also recognizes that the proposed rule may have potential application to virtual currency and related products and services. As a general matter, however, the Bureau’s analysis of mobile financial products and services, as well as virtual currencies and related products and services, including the applicability of existing regulations and this proposed regulation to such products and services, is ongoing. The proposed rule does not specifically resolve these issues.”
To read the CFPB’s proposed rule, click here.
