By Robert Kim
Robert Kim is a legal editor with Bloomberg Law. He previously served as a senior counsel on the Securities and Exchange Commission staff, manager of the Bank Secrecy Act regulatory enforcement program for the Financial Crimes Enforcement Network, and Deputy Treasury Attaché at U.S. Embassy Baghdad. He maintains Bloomberg Law’s ICO, Digital Currency and Blockchain trackers, which track all regulatory developments related to ICOs.
The March 6 publication of a letter describing the ability of the Financial Crimes Enforcement Network (FinCEN) to regulate and monitor the use of virtual currencies has prompted a wave of coverage focusing on its apparent implications for Initial Coin Offerings (ICOs). The letter discussed the views of FinCEN on the applicability of anti-money laundering/combating the financing of terrorism (AML/CFT) obligations to businesses engaging in ICOs, raising alarm in some quarters about the possible imposition of another form of regulation on ICOs. Coverage of this development has neglected to notice that this “FinCEN Letter” was not actually from FinCEN, was not mainly about ICOs, and states policies that should be unsurprising to anyone familiar with U.S. laws and regulations on AML/CFT. Participants in ICOs should consider this letter to be a warning, but they should limit how much they read into its statements as they assess the approaches toward ICOs of FinCEN, the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC).
In the rush to comment on this “FinCEN Letter,” it has gone unnoticed that the letter is not from FinCEN. It is on Department of the Treasury letterhead, issued by Assistant Secretary for Legislative Affairs Drew Maloney. FinCEN, a bureau in the Department of the Treasury, does not have anyone with “Secretary” in their title, and the Assistant Secretary for Legislative Affairs heads the Department of the Treasury’s Office of Legislative Affairs. The letter being from the Office of Legislative Affairs at Treasury headquarters and not from FinCEN makes it obvious that the letter is a Treasury statement to Congress on behalf of FinCEN, not a FinCEN statement of guidance to the public on ICOs.
The purpose of the letter is clearly stated in its opening. Addressed to Sen. Ron Wyden (D-Ore.), ranking member of the Senate Committee on Finance, the letter is a response to a request from Senator Wyden in a Dec. 14, 2017, letter for “information on the oversight and enforcement capabilities of FinCEN over virtual currency activities.” Dated Feb. 13, 2018, two months later, the letter proceeds to explain at length FinCEN’s regulatory actions applying the requirements of the Bank Secrecy Act (BSA) to virtual currency exchangers and administrators since 2011, the usefulness of Suspicious Activity Reports (SARs) filed by regulated virtual currency businesses under their BSA obligations, and how FinCEN conducts examination and enforcement actions involving virtual currency exchangers and administrators. ICOs are addressed last and briefly, in a few short paragraphs.
The brief statements on ICOs in the letter primarily address FinCEN cooperation with the SEC and the CFTC on the subject of ICOs. In a statement to Congress, FinCEN collaboration with the SEC and the CFTC is an obvious aspect to emphasize, since the SEC and the CFTC are the regulatory agencies primarily involved in the federal regulatory response to ICOs, and FinCEN collaborates with the primary regulators of financial institutions in its relations with banks, securities broker-dealers, and other regulated financial institutions. The letter’s discussion of ICOs mostly explains and emphasizes that FinCEN is “working closely with the [SEC] and the [CFTC] to clarify and enforce the AML/CFT obligations of businesses engaged in Initial Coin Offering (ICO) activities that implicate the regulatory authorities of these agencies,” with “the facts and circumstances of each case” determining how AML/CFT obligations apply to ICOs. If an ICO involves an offering or sale of securities, then it would fall under the authority of the SEC and under the AML/CFT requirements of SEC regulations, and if an ICO involves an offering or sale of derivatives, then it would fall under the authority of the CFTC and the AML/CFT requirements of its regulations.
The concern raised by the letter has been largely over one sentence in this three page long document, which reads as follows:
Generally, under existing regulations and interpretations, a developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply with AML/CFT requirements that apply to this type of MSB [money services business].
This sentence has the effect of declaring that ICOs that do not involve the offer or sale of securities or derivatives will not fall into a loophole exempting them from any coverage under the AML/CFT rules, and that FinCEN will consider the issuers of tokens in these ICOs to be in the existing category of money transmitter and will require them to follow the AML/CFT requirements applied to it. It would prevent from emerging a situation in which some ICOs are covered by AML/CFT requirements while others are not.
Following this sentence, there is a further statement regarding cryptocurrency exchanges that sell or exchange ICO coins or tokens, stating:
An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency, or other value that substitutes for currency, would typically also be a money transmitter.
Numerous law firms have already published assessments of this letter, and some cryptocurrency-focused media outlets have objected to the assertion that ICO token sellers will have to comply with AML/CFT requirements as money transmitters. These objections appear to be based on the underlying assumption that ICOs are a special class of financial transactions that should be protected from being subjected to AML/CFT requirements. Coin Center, which first published news about the letter without explaining its origin and appears to be the only source for it, raised the question, “Is it constitutional to mandate private data collection from people who are not financing intermediaries in the traditional sense, and may be better analogized to persons selling a new invention to buyers in a person to person transaction?” Other commenters have argued that AML/CFT requirements would stifle ICOs as a fundraising method for businesses, aside from those already large enough to handle regulatory burdens.
These objections ignore that ICOs have become a significant enough form of financial transaction that it is unsurprising, perhaps obvious, that FinCEN would not want to exempt them from AML/CFT requirements. In 2017, ICOs grew from a small fringe activity to billions of dollars in annual volume, with estimates of funds raised in 2017 ranging from $4 billion to over $6.5 billion. ICO token sales are inherently international, and the tokens that purchasers receive are readily convertible into other cryptocurrencies or fiat currencies through cryptocurrency exchanges. These characteristics give ICOs the potential to become a major vehicle for domestic and cross-border money laundering. As a result, as long as preventing money laundering and terrorist financing remains a U.S. policy goal, ICOs are unlikely to be exempted from the AML/CFT requirements of the BSA. Recent activity in Congress, which has included hearings in which members have been critical of the potential for illicit use of virtual currencies and proposed legislation mandating studies of the use of virtual currencies for sanctions evasion, money laundering, and terrorist financing, indicates that neither Congress nor executive branch agencies are likely to approve of excluding ICOs from BSA requirements.
Rather than categorically objecting to any form of regulation, advocates of virtual currencies and ICOs should look at the actual requirements of the BSA and determine how ICOs fit into them. The BSA and its implementing regulations are intended to be flexible and provide general guidelines on AML programs, which are supposed to be risk-based and appropriate to the situation of each institution. Appropriate AML/CFT compliance by a business that conducts a single ICO, whose AML/CFT obligations are derived from a one-off event, will be very different from that of a traditional money transmitter in the business of moving funds. Smaller ICOs that present little or no risk of money laundering or terrorist financing may have especially limited AML/CFT needs. There may also be persuasive arguments that ICOs are analogous to money transmitters but different enough to justify distinct treatment under the BSA. By examining the potential for money laundering and terrorist financing in ICOs and how it relates to BSA requirements, it will be possible to engage constructively with FinCEN and other regulatory authorities on this issue.
With almost all aspects of the regulation of ICOs currently in an uncertain state, AML/CFT requirements are only one issue that must be resolved. They are connected to the other unresolved areas, with the application to ICOs of the federal securities laws by the SEC and of the commodities laws by the CFTC affecting how AML/CFT requirements will be applied. The letter attributed to FinCEN should be considered a warning, but one which barely scratches the surface of the issue. At the same time, FinCEN is occupied with other major tasks such as the implementation of the Customer Due Diligence rule that goes into effect on May 11, 2018, a rulemaking procedure that has been in progress since 2012. Both FinCEN and the ICO sector have a great deal of work ahead of them to resolve the issue, along with related questions about the securities and commodities laws, leading to busy agendas for all of the parties involved.
Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.
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