FinCEN’S Role In Cryptocurrency Offerings
In the continuing dilemma over determining just what kind of asset a cryptocurrency is, multiple regulators have expressed opinions and differing views on regulations. Likewise, multiple regulators have conducted investigations and initiated enforcement proceedings against those in the cybersecurity space. The SEC has asserted the opinion that most, if not all, cryptocurrencies are securities; the CFTC has found them to be commodities; the IRS’s official definition is the same as the CFTC, and in particular a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, and now the Financial Crime Enforcement Network (FinCEN) has asserted that issuers of cryptocurrencies are money transmitters.
In particular, in a letter written to the US Senate Committee on Finance on February 13, 2018, FinCEN indicates that it expects issuers of initial coin offerings (ICOs) to comply with the Bank Secrecy Act (BSA), including its anti-money laundering (AML) and know your customer (KYC) requirements. FinCEN’s letter responded to a December 14, 2017 directed to it from the US Senate Committee on Finance requesting information on FinCEN’s oversight and enforcement capabilities over virtual currency financial activities. As with other agencies such as the SEC and CFTC, FinCEN desires to promote the financial innovation that can come with blockchain technology and cryptocurrencies, while preventing criminals, hackers, sanctions evaders and hostile foreign actors.
Virtual currency exchanges and administrators
FinCEN has been working with the Office of Terrorism and Financial Intelligence (FTI) to ensure that AML and procedures to combat the financing of terrorism apply to virtual currency exchanges and administrators that are in the US or do business in whole or part in the US, but do not have a physical presence here. Virtual currency exchanges and administrators have been subject to the BSA’s money transmitter requirements since 2011. In 2013 FinCEN issued specific guidance that explicitly states that virtual currency exchangers and administrators are money transmitters that must comply with the BSA. An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency or other value that substitutes for currency, is a money transmitter that is subject to the BSA.
To assist in identifying risks and the illicit use of virtual currency, including the abuse of virtual currency to facilitate cyber crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes, FinCEN examines BSA filings from virtual currency money services businesses (MSB) and other emerging payments providers, including filings pertaining to digital coins, tokens and ICOs. Trends, red flags and risks and reported to US law enforcement and other governmental agencies.
Entities that are subject to the BSA must: (i) register with FinCEN as a MSB; (ii) prepare a written AML compliance program that is designed to mitigate risks, including AML risks, and to ensure compliance with all BSA requirements including the filing of suspicious activity reports (SAR) and currency transaction reports; (iii) keep records for certain types of transactions at specific thresholds; and (iv) obtain customer identification information sufficient to comply with the AML program and recordkeeping requirements.
SAR reports that are filed with FinCEN have identifying information about the owner/customer. In cases where a bitcoin address is identified, FinCEN performs a blockchain analysis which can often enable investigators to tie it to a virtual currency exchanger, hosted wallet, or other source that may have the identity of the account owner. Blockchain network analytic tools can also tie a targeted bitcoin address to other persons that have transacted with a particular bitcoin address. The investigative process may involve the issuance of subpoenas and FinCEN cooperates with law enforcement to help identify and trace bitcoin used in criminal activity.
FinCEN also conducts reviews and exams of registered MSBs. Of the approximate 100 registered entities, FinCEN has examined approximately one-third and has initiated several enforcement proceedings as a result of those exams. However, financial crimes and terrorism are international issues and not all countries regulate virtual currency businesses or require them to keep records. Accordingly, FinCEN has been working to encourage foreign countries to regulate these businesses and to cooperate in criminal investigations.
ICO issuers
FinCEN is working with the SEC and CFTC to clarify and enforce AML and counterterrorism obligations of businesses that engage in ICO activities. Although the FinCEN letter indicates that the obligation to comply with the BSA and its ensuing AML, registration, SAR and other requirements depends on the nature of the financial activity and a facts-and-circumstances analysis, ICO participants have unilaterally interpreted the FinCEN letter as requiring all ICO issuers to comply in one way or another.
FinCEN specifically states that an issuer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value, including fiat currency, is a money transmitter that must register as an MSB and comply with the BSA, including AML and KYC procedures. However, to the extent that an ICO involves the sale of securities or derivatives that would be under the jurisdiction of the SEC through its regulation of broker-dealers or CFTC through its regulation of merchants and brokers in commodities, those entities could comply with the SEC and CFTC’s AML and counterterrorism requirements.
The Securities Exchange Act of 1934 (“Exchange Act”) specifically requires brokerage firms to comply with the BSA and FinCEN rules. Brokerage firms are also required to comply with AML rules established by FINRA, including FINRA Rule 3310. The purpose of the AML rules is to help detect and report suspicious activity including the predicate offenses to money laundering and terrorist financing, such as securities fraud and market manipulation. FINRA also provides a template to assist small firms in establishing and complying with AML procedures.
In May 2016, FinCEN issued new final rules under the BSA requiring financing institutions, including brokerage firms, to adopt additional anti-money laundering (AML) procedures that include specific due diligence and ongoing monitoring requirements related to customer risk profiles and customer information. The rules also require financial institutions to collect and verify information about beneficial owners and control person of legal entity customers. My blog on those rules can be read HERE.
FinCEN requires that financial institutions address the following four key elements in all of their AML programs: (i) customer identification and verification; (ii) beneficial ownership identification and verification; (iii) understanding the nature and purpose of customer relationships to develop risk profiles; and (iv) ongoing monitoring for reporting suspicious transactions and maintaining and updating customer information.
Further Reading on DLT/Blockchain and ICOs
For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.
For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.
For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.
For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.
For an update on state-distributed ledger technology and blockchain regulations, see HERE.
For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.
For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.
For a review of the CFTC role and position on cryptocurrencies, see HERE.
For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.
To learn about SAFTs and the issues with the SAFT investment structure, see HERE.
To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.
For more information on platforms that trade cryptocurrencies and more on the continued regulatory confusion in the space, see HERE.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Contact Legal & Compliance LLC. Technical inquiries are always encouraged.
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Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Legal & Compliance, LLC 2018
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FinCEN Updates Due Diligence Rules
On May 11, 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued new final rules under the Bank Secrecy Act requiring financing institutions, including brokerage firms, to adopt additional anti-money laundering (AML) procedures that include specific due diligence and ongoing monitoring requirements related to customer risk profiles and customer information. In addition, the new rules require financial institutions to collect and verify information about beneficial owners and control person of legal entity customers.
The Securities Exchange Act of 1934 (“Exchange Act”) specifically requires brokerage firms to comply with the Bank Secrecy Act. FinCEN provides minimum rules. Brokerage firms are also required to comply with AML rules established by FINRA, including FINRA Rule 3310. The purpose of the AML rules is to help detect and report suspicious activity including the predicate offenses to money laundering and terrorist financing, such as securities fraud and market manipulation. FINRA also provides a template to assist small firms in establishing and complying with AML procedures. As of the date of this blog, FINRA has not updated Rule 3310 or its form template.
The new rules will make the difficult process of opening brokerage accounts even more difficult, especially for foreign individuals and entities and U.S. individuals and entities operating through offshore entities. The new rules could impact the ongoing process of depositing and trading in penny stocks, even for existing brokerage firm clients. FinCEN initially issued advance notice of proposed rulemaking in March 2012 and issued proposed rules in August 2014. A push to issue final rules gained momentum following the release of the Panama Papers. The new rules become effective for new customer accounts opened on or after May 11, 2018; however, as discussed below, where appropriate it may have retroactive application.
FinCEN requires that financial institutions address the following four key elements in all of their AML programs: (i) customer identification and verification; (ii) beneficial ownership identification and verification; (iii) understanding the nature and purpose of customer relationships to develop risk profiles; and (iv) ongoing monitoring for reporting suspicious transactions and maintaining and updating customer information.
Obligation to identify and verify beneficial ownership
The USA Patriot Act grants authority to FinCEN to establish rules for financial institutions to identify and verify customer information and establish AML procedures in general. All financial institutions are required to have minimum AML procedures, and the application of these procedures has been the subject of many enforcement proceedings. The initial customer identification program rule (CIP Rule) was enacted in 2003 and required financial institutions to identify any individual or entity that opened an account but did not require identification of beneficial ownership.
A “legal entity” is defined as a corporation, limited liability company, partnership or other entity that is created by the filing of a public document with a U.S. state or foreign governmental body. Under the new rules, the financial institution will need to identify beneficial owners of a legal entity that own (i) 25% or more of the equity of the legal entity; and (ii) any control persons over the legal entity, including officers, directors and senior management. Certain entities are excluded from the definition of an “entity” for purposes of the CIP rules, including financial institutions, banks, bank holding companies, certain pooled investment funds, state regulated insurance companies and foreign financial institutions.
Subject to certain exclusions, the new rule requires financial institutions to identify and verify the beneficial owners of their legal entity customers. The rulemaking process included numerous comments on this requirement. As a concession, the final rule generally does not contain a requirement that the financial institution verify that a listed beneficial owner in fact holds the disclosed ownership interest or exerts actual control over the entity.
As with most such rules, the financial institution can establish written processes and procedures tailored to that institution and its operations. Such processes and procedures must include a consideration of both the ownership test and control test of beneficial ownership. A financial institution must collect information on all individuals who either directly or indirectly own 25% or more of the equity of an entity. Where a financial institution has questions or determines there are risk factors, they may collect identifying information on owners with a lower percentage as well. In addition, the financial institution must collect information on all individuals that have the ability to control, manage or direct the entity, including officers, directors and key management.
The terms “direct and indirect” and “control” remain undefined and are to be broadly construed based on facts and circumstances to encompass all forms of potential ownership and control. Likewise, when making risk and knowledge assessments, the financial institution must consider all facts and circumstances and is held to a “reasonableness” standard.
Financial institutions must verify the collected information. The original CIP Rule established verification requirements based on risk. The same risk-based verification processes remain in place, with some modifications. In essence, the financial institution must gather due diligence, including corporate records, ownership records and the like, and continue such process until it is satisfied it has enough information on the beneficial owners of that particular entity, considering the risk imposed by that entity.
There are two significant modifications from the CIP Rule. In particular, a financial institution may rely on photocopies of documents rather than originals, and the institution may rely on disclosures of ownership from the entity itself except where it has knowledge of facts that would call into question the reliability or veracity of such information.
The risk assessment in the CIP Rule includes a consideration of all relevant facts and circumstances, including, but not limited to: (i) type of account; (ii) method of opening account; (iii) size of account and trading activity; (iv) type of identifying customer information; (v) relationship with the customer, including other accounts with the same beneficial owners, length of relationship, personal knowledge, and account activity; (vi) whether the customer has a physical address or physical business location; (vii) whether the customer has a U.S. tax identification number; and (viii) historical activity, including a suspicious activity.
Although the rule sets a firm requirement that financial institutions complete written procedures and apply them to all accounts opened on or after May 11, 2018, FinCEN is clear that a financial institution has a broad requirement to monitor and know its customers. Where risks are identified, additional procedures as outlined in the new rules should be applied to accounts, effective immediately. In addition, financial institutions should have ongoing monitoring procedures and may, where appropriate, go back and ask for information on existing accounts, as well as require updated information for accounts on a continuing basis. For instance, if an account has suspicious activity or contradictory ownership or control information is brought to the financial institution’s attention, there would be an obligation to conduct further due diligence and update and verify ownership and control information.
Basic AML Procedure Requirements
The USA Patriot Act sets out the basic requirements for effective AML policies and procedures. In particular, an effective AML program requires: (i) written policies and procedures; (ii) a designated compliance officer; (iii) an ongoing training program; (iv) an independent audit; and (v) customer due diligence. The new rules are focused on the fifth element: customer due diligence.
An effective customer due diligence process must have procedures for effectively understanding a customer relationship and establishing a customer risk profile, and for ongoing monitoring and compliance procedures, including those related to detecting and reporting suspicious activities and updated customer beneficial ownership and control information.
The Bank Secrecy Act imposes an obligation on broker-dealers to file a SAR with FinCEN to report any transaction (or a pattern of transactions) involving $5,000 or more, in which it “knows, suspects, or has reason to suspect” that it “(1) involves funds derived from illegal activity or is conducted to disguise funds derived from illegal activities; (2) is designed to evade any requirements of the Bank Secrecy Act; (3) has no business or apparent lawful purpose and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts; or (4) involves use of the broker-dealer to facilitate criminal activity.”
SEC guidance points out red flags that should cause a broker to conduct further investigation as to whether a SAR needs to be filed, including:
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host ofLawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Contact Legal & Compliance LLC. Technical inquiries are always encouraged.
Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.
Download our mobile app at iTunes.
Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Legal & Compliance, LLC 2016
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