NY Regulator Releases First Regulatory Framework For Virtual Currency

by Manatt, Phelps & Phillips, LLP

It happened: Benjamin Lawsky, Superintendent of New York’s Department of Financial Services (DFS) announced the release of the DFS’s much-anticipated proposal for a BitLicense, stating “We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation.” However, many were surprised by the complexity of the proposal – a comprehensive framework for licensing and regulating virtual currencies, the first of its kind in the United States.

Beginning July 23, the public will have 45 days to comment on the proposal which requires a person to seek a BitLicense before engaging in any one of five different types of activities in New York or involving New York residents: (1) receiving or transmitting virtual currency; (2) securing, storing, holding, or maintaining custody or control of virtual currency on behalf of others; (3) buying or selling virtual currency as a customer business – distinct from personal use; (4) performing retail conversion services (including the conversion of fiat currency or other value into virtual currency and vice versa and the conversion of one form of virtual currency into another); and (5) controlling, administering, or issuing a virtual currency (excepting virtual currency miners).

The New York regulator laid out a myriad of requirements both for the BitLicense application as well as ongoing compliance, including a robust anti-money laundering compliance program, certain Bank Secrecy Act reporting and recordkeeping requirements such as reports that must be filed with the departments, advertising and marketing requirements, cybersecurity program, business continuity and disaster recovery plan, and a customer complaint process and consumer protections intended, among other things, to ensure that customers are provided with “clear and concise” disclosures about the risks of virtual currency. Key requirements include:

  • Customer asset safeguards. The DFS will set appropriate capital levels for each licensee based on a number of factors. Also, a licensee must hold virtual currency of the same type and amount as any currency owed or obligated to a third party as well as maintain a bond or trust account in USD “in such form and amount as is acceptable to DFS” for the protection of customers.
  • Customer receipts. A licensee must provide detailed receipts to customers that include the name and contact information for the business, including a telephone number; the type, value, date, and precise time of the transaction; the fee charged; if applicable, the exchange rate; a state of the liability of the licensee for nondelivery; and a statement about the licensee’s refund policy.
  • Anti-money laundering compliance. The DFS is proposing that licensees conduct both initial and annual risk assessments and establish, maintain and enforce risk-based anti-money laundering compliance programs, including customer identification programs. The DFS is also proposing the retention of certain information on each transaction and notification of any transaction or series of transactions involving virtual currency of more than USD 10,000 in one day, by one person within 24 hours of the transaction. Customer identities must be verified at account opening and checked against OFAC’s Specially Designated Nationals list. Enhanced due diligence is required for foreign entities and may be required for others based on certain factors, including high-risk customers, high-volume accounts, or accounts where a suspicious activity report has been filed. Without the exceptions provided under federal law, accounts for foreign shell entities are prohibited. Also going beyond federal requirements, the DFS is proposing that licensees monitor for and immediately report transactions that could indicate tax evasion, money laundering, or other illegal activity. In addition, any company not subject to the federal suspicious activity reporting requirement will be required.
  • Recordkeeping and official roles. Every licensee must designate a qualified employee to serve as a Chief Information Security Officer, responsible for overseeing and implementing the cybersecurity policy. Licensees must also designate another person as the compliance officer to coordinate and monitor compliance obligations. Records and books must be kept, demonstrating compliance, documenting transaction information and details related to the investigation of consumer complaints. Financial statements will be due to the DFS on a quarterly and annual basis.
  • Grandfathered activities. The proposal appears to grandfather activities conducted as of the effective date of the regulation as long as the entity applies for a license within 45 days of the effective date.

Licensees will be subject to examination by the DFS “whenever the superintendent deems necessary” but no less than once every two calendar years. Exams will assess the licensee’s financial condition, safety and soundness, management policies, and compliance with laws and regulations.

The proposed regulations may be revised by the DFS following the public comment period.

To read the proposed regulations, click here.

Why it matters: This proposal is the promised next step in a process begun more than a year ago when a number of entities received DFS subpoenas. The public hearings that followed in January were part of the effort to strike the right balance. Superintendent Lawsky said, “Setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets.”

This proposal could be viewed as creating parity with money transmitters, although it goes a bit further by addressing in regulation a number of issues that have become regulatory best practices or that have fallen into regulatory gaps.

The Bitcoin community generally has not received this proposal well. As proposed, only the best capitalized firms will be able to obtain licenses – at least in the short term – and it will stifle too much of the entrepreneurial zeal in the community. It is also likely the DFS will receive an overwhelming response to kill the proposal. However, at this point, the proposal represents the best option for the Bitcoin community to move forward in New York.

In the end, the DFS and the community need to work together to strike that right balance if virtual currencies are to gain broader acceptance and be allowed in New York.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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