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U.S. Law Enforcement Actions Against Cryptocurrency Businesses: A Review And Suggested Guidance

Last Updated March 4, 2021 4:46 PM
Lester Coleman
Last Updated March 4, 2021 4:46 PM

The rapid growth of cryptocurrencies in recent years has resulted in a number of law enforcement actions by several U.S. government agencies. These actions demonstrate U.S. regulators’ interest in investigating fraud and other activities, according to Latham & Watkins , a Los Angeles-based, U.S. law firm. To give the cryptocurrency industry an overview of what agencies are taking action and provide insight into how to meet the various regulations, the law firm has released a report, “Enforcement Trends in Cryptocurrency.”

“No doubt, in the coming years, cyptocurrencies will face increasing scrutiny, and thus it behooves both businesses and legal practitioners to monitor the enforcement and regulatory landscape,” the report states.

The report reviews actions by the Securities & Exchange Commission (SEC), The Department of Justice, the Commodities Futures Trading Commission (CFTC), the Federal Trade Commission (FTC) and the Financial Crimes Enforcement Network (FinCEN). Actions include securities and wire fraud, securities violations, Dodd-Frank Act violations, anti-money laundering (AML) and Bank Secrecy Act violations.

Actions To Date

Enforcement actions include:

SEC v. Trendon Shavers and Bitcoin Savings and Trust (BTCST)

The SEC charged Trendon Shavers and his firm, BTCST in July 2013 with securities fraud for operating a bitcoin-based Ponzi scheme. SEC claimed Shavers told investors he needed bitcoins to sell to people who wanted to buy large quantities of virtual currency and promised returns of about 7% weekly and 1% daily. While Shavers argued the investments were not securities, the court ruled bitcoins are legal currency and, therefore, subject to SEC rules.

The court in September 2014 ordered Shavers to pay more than $40 million in penalties and disgorgement. He also pled guilty in September 2015 to charges of securities fraud for fraudulently obtaining $800,000 in bitcoin.

SEC v Erik T. Voorhees

SEC in June 2014 charged Erik Voorhees with offering securities without registering the offerings. Investors paid for shares with bitcoins. In a settlement with SEC, Voorhees admitted to failing to register the securities and agreed to a full disgorgement of about $15,000 in profits and a $35,000 civil penalty.

SEC V. BTC Trading Corp. and Ethan Burnside

SEC in 2014 charged Ethan Burnside in connection with online trading platforms to trade securities with virtual currencies which he operated as unregistered virtual securities exchanges and brokers that executed more than 400,000 trades. He also offered shares of two virtual currency businesses without registering them with the SEC. Burnside agreed to pay $58,387 in disgorgement and pre-judgment interest and a $10,000 civil penalty and a two-year bar from the industry.

SEC v. Sand Hill Exchange, et al.

In June of 2015, SEC settled with Sand Hill Exchange, an online exchange that sold derivative contracts and was paid in bitcoins for violating the Dodd-Frank Act. Dodd-Frank requires securities-based swaps offered to an investor that does not meet certain standards to have a registration statement effective for the offering and also requires contracts to be sold in a national securities exchange.

The SEC also charged Sand Hill exaggerated its trading, controls, operations and financial backing. Sand Hill agreed to a $20,000 civil monetary penalty and to cease from future violations.

FTC v. BF Labs, Inc.

The FTC in September 2014 filed charges against Butterfly Labs, which sold computers to mine bitcoins. FTC sought a permanent injunction and temporary restraining order relating to unfair and deceptive marketing practices. FTC charged the company with coaxing customers into pre-ordering computers to mine bitcoins but did not deliver them or delayed delivery to the point the machines were obsolete.

The complaint said the company took in between $20 and $50 million from more than 20,000 people. The court granted the restraining order, froze assets and issued a permanent injunction, demanding the company stop misrepresenting products and services. Butterfly was able to resume business but ended its pre-order business model, updated pre-order refund process and submitted reports to the court on orders and manufacturing.

U.S. v. Murgio and U.S. v. Lebedev

In July 2015, the U.S. Attorney’s Office for the Southern District Court of New York charged Yuri Lebedev and Anthony Murgio with operating an unlicensed money transmitting firm. They allegedly ran Coin.mx as a front company and a credit union in violation of federal anti-money laundering laws. They allowed customers to exchange cash for bitcoins while knowing customers were transacting in criminal proceeds.

The office said Murgio exchanged cash for bitcoins for cyber-attack victims in which criminals blocked access to the victim’s computer until a bitcoin ransom was paid. Coin.mix exchanged at least $1.8 million for tens of thousands of customers and did not file required suspicious activity reports in violation of AML laws. Cases are pending.

In re Ripple Labs Inc.

Ripple Labs Inc. and its subsidiary, XRP II LLC in May 2015 settled allegations of Bank Secrecy Act (BSA) violations. The U.S. Attorney General’s Office of the Northern District of California and the IRS opened an investigation while FinCEN brought a civil enforcement action. The companies agreed to pay $700,000 in total penalties (including $450,000 to settle criminal charges).

Ripple Labs violated BSA requirements and sold virtual currency without first registering with FinCEN and failed to implement and maintain a proper AML program. A Ripple Labs subsidiary also violated BSA provisions by failing to implement an AML program and failed to file a suspicious activity report (SAR) for several transactions.

Silk Road Trilogy: U.S. v. Ulbricht

In Feb. 2013, Ross Ulbricht was indicted in the Southern District Court of New York for distributing narcotics, conspiring to commit computer hacking, trafficking in false identities, conspiring to commit money laundering and other charges. Following a trial, he was convicted of the charges and was sentenced to life in prison and ordered to forfeit about $184 million.

U.S. v. Faiella and U.S. v. Shrem.

In January of 2014, the U.S. Attorney’s Office for the Southern District of New York charged Robert Faiella, an underground bitcoin exchanger, and Charlie Shrem, the CEO and compliance officer of BitInstant, a bitcoin exchange, with selling more than $1 million in bitcoins to Silk Road users, enabling illegal purchases.

Faiella pled guilty in September 2014 and was sentenced to four years in prison and forfeited $950,000. Shrem facilitated Faiella and allowed him to buy bitcoins for Silk Road customers. He failed to file SARs to identify illegal activity and helped Faiella evade AML restrictions. In December 2014, Shrem was sentenced to two years in prison after pleading guilty to aiding an unlicensed money transmitting business. He agreed to forfeit $950,000.

U.S. v. Force and U.S. v. Bridges

Former DEA agent Carl Force in July 2015 pled guilty to money laundering, obstructing justice and extortion related to the Silk Road investigation after being charged in the Northern District of California in March 2015.

Force worked on the investigation for two years and admitted to selling Ulbricht information about the investigation, stealing his bitcoins, extorting third parties, communicating via encrypted messaging and selling the story to a motion picture firm for $240,000. Force admitted falsifying reports and stealing more than $100,000 in bitcoins. He also invested in a bitcoin exchange company and served as its chief compliance officer and misappropriated about $300,000. He was sentenced in October 2015 to 78 months in prison and ordered to forfeit $340,000 in addition to proceeds he previously agreed to relinquish.

Another former agent, Shaun Bridges, pled guilty to money laundering and obstruction of justice for diverting more than $800,000 in cryptocurrency relating to his Silk Road investigation. He was sentenced to 71 months prison and ordered to pay about $1.1 million.

In re Conflip

The CFTC settled charges in September 2015 against Coinflip Inc. and its CEO for operating a bitcoin options trading platform called Derivabit for violating the Commodity Exchange Act. Coinflip operated a facility for trading and processing commodity options without registering as a swap execution facility or a designated contract market. This marked the CFTC’s first enforcement action for bitcoin and bitcoin derivatives. The action served as a pronouncement that cryptocurrencies are classified as commodities.

In re TeraExchange LLC

In September 2015, the CFTC settled charges against TeraExchange LLC, a swap execution facility (SEF), claiming the company organized the execution of two prearranged and fully offsetting USD-to-bitcoin trades with a notional $500,000 amount on its SEF. TeraExchange announced the first bitcoin derivative transaction on a regulated exchange without disclosing the trades were preoperational, which CFTC said gave the impression of actual trading.

Enforcement Expected To Increase

Enforcement officials will scrutinize cryptocurrency activity using existing regulations, Latham & Watkins noted. It advised companies to executive record-keeping and compliance efforts to reduce compliance costs.

Regulators have introduced reporting, recordkeeping and KYC rules for cryptocurrencies that are the same as those applied to traditional securities and currencies.

FinCEN has stated its MSBs rules apply to virtual currencies. An exchanger or administrator has to register as an MSB and must meeting BSA recordkeeping rules.

They must assess the risk of money laundering or terrorist financing. They have to keep records on the receiver and the transmitter of any transfer of $3,000 and above. They must have a record for each currency exchange greater than $1,000.

The New York BitLicense requires an AML program, including risk assessment, dedicated compliance function, audit function, prohibitions, records, reporting rules, office of foreign assets control compliance and customer identification program.

Some states, such as Connecticut, require a cryptocurrency business to obtain a money transmitter’s license.

Other states, such as California, are introducing cryptocurrency laws modeled on the New York BitLicense.

Strict Recordkeeping Imperative

Strict recordkeeping rules are imperative for any business using cryptocurrency, Latham & Watkins noted. The transactions, while private, are not completely anonymous.

As cryptocurrency grows, legal scrutiny will increase, especially in regard to AML and KYC. Transactions will yield more data that can be attributed to the parties involved.

Transaction data should be organized and stored to ensure compliance with recordkeeping rules.

Money Transmitters Face Strict Rules

Businesses regarded as money transmitters are subject to KYC rules, which require companies to verify the identity of customers. KYC rules will likely impact virtual currency as anonymity is a selling point for many customers and as transactions grow globally with the near-immediate settlement.

Businesses will have to develop KYC policies that balance consumer privacy with regulatory requirements that mandate a knowledge of all transaction parties.

MSBs are required to monitor transactions and report if a transaction meets a certain threshold or in cases of suspicious activity. All MSBs must file currency transaction reports on cash transactions exceeding $10,000 in a day. These include information about the account owner’s identity and occupation.

MSBs also have to file a currency or monetary instruments report for transporting, shipping or mailing a monetary instrument in an amount above $10,000.

Financial companies and MSBs must also file an SAR for activity for $200,000 or more that is deemed suspicious. Financial firms and cryptocurrency-related firms have to ensure their reporting infrastructure applies equally to cryptocurrency transactions.

Compliance with AML laws is also essential and apply to anyone regardless of their being a financial company or an MSB.

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