On September 16, 2020, the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) published an advanced notice of proposed rulemaking (ANPRM) seeking comments on regulatory changes to enhance the effectiveness of anti-money laundering compliance programs of regulated financial institutions. As described in FinCEN’s press release, the ANPRM presents an opportunity for financial institutions to provide comments on “a wide range of questions pertaining to potential regulatory amendments under the Bank Secrecy Act (BSA).” While FinCEN has published a number of rules in recent years through formal notice and comment procedures, the rules have been fairly targeted to issues such as customer due diligence. FinCEN has also issued a number of guidance documents, including guidance applying FinCEN’s rules to certain entities in the blockchain industry, but did not accept public comments from industry at the time. Therefore, the publication of the ANPRM presents a relatively rare opportunity for regulated entities to be heard on a range of AML programmatic and compliance issues.
As regulators from across the US government continue to grapple with the rapid expansion of financial technology (FinTech) and digital assets, the Office of the Comptroller of the Currency (OCC) has adopted a welcoming position toward such technology and taken three recent steps with the potential to significantly benefit industry. First, the OCC is planning to propose a new national bank charter for payments companies, including those dealing with digital assets, that may allow such companies to obtain a single national license rather than licenses in each state in which they operate. Second, on July 22, 2020, the OCC issued an interpretive letter clarifying that national banks and federal savings associations may provide cryptocurrency custody solutions on behalf of their customers. Third, on June 4, 2020, the OCC issued an advanced notice of proposed rulemaking (ANPR) seeking comments on the digital activities of national banks and federal savings associations. All three developments have the potential for significant, positive impact on industry.
On June 24, the five-year anniversary of New York’s virtual currency licensing regime known as the BitLicense, the New York Department Financial Services (DFS) published new guidance and FAQs related to approval for use of specific currencies and the licensing process, as well as a proposed conditional licensing framework. The measures offer important insight for companies holding or considering applying for a BitLicense and represent the most significant changes and proposed changes since the regulation’s initial issuance in 2015.
Guidance for Adoption or Listing of Virtual Currencies
Under the BitLicense regime, licensees and approved charter holders under the New York Banking Law (collectively, “VC Entities”) are required include virtual currencies (“coins”) they plan to “list” in their initial application to DFS. Historically, in order to list new assets VC Entities were required to go back to DFS to seek approval. Given the proliferation in coins available over the past five years this became a cumbersome and time-consuming system. In order to remedy this issue, in December of 2019, DFS issued proposed guidance to allow licensees to “offer and use new coins in a timely and prudent manner.” After receiving public comments, DFS has now published final guidance creating “two separate frameworks designed to enhance speed and efficiency in a VC Entity’s adoption or listing of coins.” These two frameworks include (1) “a general framework for a VC Entity’s creation of a firm-specific policy for the adoption or listing of a new coin, without DFS’s prior approval, through the process of self-certification” and (2) “a general framework for the process of Greenlisting coins for wider usage.”
In a series of remarks over the past year, SEC Commissioner Hester Peirce laid the groundwork for a potential SEC safe harbor for developmental token offerings, which could provide a registration exemption for three years to give token networks a sufficient incubation period to achieve “maturity.”
The theory behind the proposed safe harbor is that the current regulatory framework functions as a barrier to launching token networks because offerors fear they may be treated as securities before they have time to mature into decentralized networks. The safe harbor would exempt certain tokens, subject to various conditions, with the aim of creating a regulatory environment that promotes fairness and predictability, while encouraging new offerings and the concomitant competition and innovation that could flow therefrom.
In his testimony before the Senate Finance Committee, on February 12, Treasury Secretary Steven Mnuchin stated that the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) will soon release new regulations related to cryptocurrency. FinCEN is responsible for issuing and implementing anti-money laundering (AML) and counter-terrorist financing (CTF) regulations applicable to certain US financial institutions. According to Secretary Mnuchin:
We’re spending a lot of time on the issue of cryptocurrencies and digital payment systems …. on pure cryptocurrencies like Bitcoin, and there are others, we want to make sure that these are not used as the equivalent of secret bank accounts. So, we are working with FinCEN, and we will be rolling out new regulations to be very clear on greater transparency so that law enforcement can see where the money is going and that this isn’t used for money laundering.
FinCEN previously issued guidance on virtual currency in 2013 and 2019, which clarify how FinCEN’s existing rules for money services businesses, or MSBs, apply to “administrators,” “exchangers,” and “users” of what the agency calls “convertible virtual currency.” The MSB rules apply to certain persons dealing in fiat currency, convertible virtual currency, and other “value that substitutes for currency,” but does not treat MSBs dealing in convertible virtual currency differently than other types of MSBs. Therefore, if FinCEN were to issue new regulations specifically addressing cryptocurrencies or digital assets more broadly, such regulations would be a first of its kind.
On November 15, Director Kenneth Blanco of the Financial Crimes Enforcement Network (FinCEN) offered his most extensive remarks on blockchain since the agency’s release of updated guidance in May. Speaking at the Chainalysis Blockchain Symposium, Director Blanco offered a number of insights on FinCEN’s current priorities and industry trends.
Suspicious Activity Reports
According to Director Blanco, since the publication of FinCEN’s guidance in May, the agency has received over 10,000 suspicious activity reports (SARs) related to convertible virtual currency (CVC) with 6,600 of those SARs filed by CVC-related businesses, including exchanges and kiosks. Director Blanco noted that this was a significant increase in SAR volume, particularly from CVC-related businesses, and included SARs from dozens of businesses that had never filed a SAR with FinCEN prior to the publication of the guidance.
Director Blanco also highlighted a couple of trends in SAR reporting. The first is SARs related to “potential unregistered, foreign-located money services businesses (MSBs), specifically, Venezuela-based P2P exchangers.” A foreign-located MSB is required to register with FinCEN if it conducts business in whole or in “substantial part” in the United States. (Determining precisely what constitutes “substantial part” continues to be an area of uncertainty for industry, which Director Blanco did not address.) A second trend was CVC kiosk operators reporting on “activity indicative of scam victims upon identification of new customers who have limited knowledge of convertible virtual currencies, particularly those in vulnerable populations, including the elderly.”
On October 11, the leaders of the Commodities Futures Trading Commission (CFTC), Financial Crimes Enforcement Network (FinCEN), and the Securities and Exchange Commission (SEC) issued a joint statement regarding anti-money laundering (AML) compliance for persons engaged in certain activities involving digital assets. While the statement largely reaffirms known agency guidance and existing regulations, it is noteworthy for a number of reasons.
First, the joint statement, issued from multiple regulators, is the first of its kind in the digital asset space with respect to AML and may indicate an intent of regulators to show that their approach to AML compliance is aligned and to coordinate more closely on AML compliance going forward. While each of the three regulators has published guidance regarding digital assets and has engaged in related enforcement actions, there has not been any public indication to date that such efforts have been coordinated across agencies.
The IRS has released new guidance on the U.S. tax treatment of cryptocurrency for the first time since 2014. The guidance includes Revenue Ruling 2019-24, which provides guidance on the tax treatment of hard forks. The IRS also released a series of FAQs covering a variety of topics that expand on Notice 2014-21.
Revenue Ruling 2019-24
Revenue Ruling 2019-24 generally concludes on two scenarios involving hard forks. A hard fork occurs when a blockchain undergoes a protocol change resulting in a permanent diversion from the legacy or existing blockchain, which may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. In the first scenario, the cryptocurrency blockchain experiences a hard fork but the taxpayer does not receive units of a new cryptocurrency, and in the second scenario, the taxpayer receives units of new cryptocurrency “as a result of an airdrop of a new cryptocurrency following the hard fork.” The Revenue Ruling concludes that the taxpayer does not have income in the first scenario. However, in the second scenario, the taxpayer has ordinary income because he has experienced an accession to wealth. The income arises at the time of the airdrop because the taxpayer is, at that time, able to exercise dominion and control over the forked cryptocurrency.
The IRS has confirmed that it has begun sending letters to taxpayers with virtual currency transactions that potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly. In the announcement, IRS Commissioner Chuck Rettig says that “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”
The IRS identified the taxpayers receiving these letters through various ongoing IRS compliance efforts, likely including customer information that the IRS received last year after successfully enforcing a John Doe summons against Coinbase. The IRS has said that it expects more than 10,000 taxpayers will receive these letters by the end of August.
On April 29, blockchain took over the Cyberlaw Podcast once again with Alan Cohn, Gary Goldsholle, Will Turner, and guest speaker, Jeff Bandman, covering all things blockchain and cryptocurrency. We dove right into the recent activity from the SEC, namely, the Framework for “Investment Contract” Analysis of Digital Assets and the No-Action Letter issued to TurnKey Jet, Inc. (TurnKey) for a digital token. Continue Reading Blockchain Takes Over Episode 261 of the Cyberlaw Podcast