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Lawyers who accept bitcoin as payment for legal services must straightaway convert the digital currency into U.S. dollars and credit the client’s account, the Nebraska Supreme Court’s ethics committee advised Sept. 11 (Nebraska Supreme Court Ass’n Advisory Comm., Op. 17-03, 9/11/17).
The opinion appears to be the first from any ethics panel in the United States to assess how ethics rules apply to lawyers’ receipt of virtual currency through blockchain technology. A growing number of law firms are taking bitcoins as payment, the committee noted.
Lawyers who talked with Bloomberg BNA about the opinion didn’t disagree with most of it, but offered additional thoughts for lawyers on the subject.
Daniel S. Friedberg, the co-chair of the payments practice at Fenwick & West LLC, endorsed the opinion’s advice for lawyers to convert bitcoin to dollars immediately upon receipt. Friedberg’s financial technology practice includes advising clients on digital payment systems.
Lawyers should take pains to make sure clients understand the process, Friedberg told Bloomberg BNA. “It’s important to explain the rules of the game, so that clients understand the exact financial consequences of the transaction,” he said.
Stephen T. Middlebrook, another lawyer with expertise in virtual currency, told Bloomberg BNA that in general he thinks the opinion is fine and probably helpful, but he has questions about certain aspects of it. He’s of counsel to Womble Carlyle Sandridge & Rice LLP, Atlanta.
Middlebrook said the opinion isn’t wholly accurate in describing bitcoin, and it doesn’t clearly distinguish between accepting bitcoin for earned fees versus retainers. Also, the opinion isn’t nuanced regarding bitcoin escrow arrangements, in his view.
Another digital currency expert, John S. Wagster, said the opinion really just asks attorneys to abide by the same rules with cryptocurrency as they’re required to abide by with regular currency.
“I don’t see any really new ground being turned here,” Wagster told Bloomberg BNA. He practices with Frost Brown Todd in Nashville, Tenn.
In an interview with Bloomberg BNA, Friedberg noted that there are virtual currency exchanges where a law firm can set up an account and have bitcoin or other virtual currency automatically convert to dollars upon receipt. Then the law firm can send the client a thank-you letter that says the firm is crediting the client’s account for the exact converted amount.
However, the firm should have already described that process in the client’s engagement agreement, Friedberg said. For example, the firm should explain in writing that it accepts bitcoin as payment for fees but that it will immediately convert the bitcoin to dollars at the exchange’s published market price, and the client will receive credit for that amount.
Firms should select an exchange that’s properly registered with FinCEN, a division of the Department of Treasury, and licensed with the appropriate states, Friedberg said.
Friedberg noted that different payment processors convert bitcoin at different prices because there’s no single market price for bitcoin. The firm should identify its chosen processor to the client, as well as the exchange terms, to avoid any later dispute about the exchange, he said.
The Nebraska opinion gives a quick primer on bitcoin and related terms such as “wallet” (computer file where bitcoins are stored) and “private key” (unique code that authorizes change that debits sender’s wallet and credits receiver’s wallet).
Also, the opinion mentions using “multisignature” accounts as a security precaution, and it discusses holding bitcoins in escrow.
Friedberg noted, however, that the opinion doesn’t go into the subject of multisignature bitcoin transactions as an alternative to traditional escrow arrangements. These “ multisig” transactions require private keys from more than one user to release the bitcoin.
For example, bitcoin can be distributed to a wallet where they will be held pending some event or decision, until two people holding private keys agree to release the funds. Or those two people can involve a third person and agree that to release the funds, two out of three (or all three) must agree, Friedberg said.
Through multisignature technology, the blockchain offers an opportunity to sometimes eliminate the need for a traditional escrow agent altogether, Friedberg noted.
Middlebrook told Bloomberg BNA that a few details in the opinion’s description of bitcoin are a little out of date. In particular, the opinion says there are virtually no fees associated with transfers and that transfers are instant, but that’s not really true these days, he said.
Also, Middlebrook noted that the committee seems to believe that the volatility in the price of bitcoin raises an ethical issue because it could mean an lawyer is overpaid or underpaid.
But if a client pays a fee for services rendered, whether priced in bitcoin or dollars, and the client gets credited at a fair exchange rate, it doesn’t seem to be particularly relevant whether the lawyer keeps the fee in bitcoin or exchanges it for dollars, he said.
Middlebrook said that when a client uses bitcoin to pay a retainer, it makes sense for a lawyer to convert the bitcoin to dollars so the value of the retainer won’t change with fluctuations in bitcoin’s value. However, the opinion as written indicates that lawyers must exchange bitcoin immediately whenever they accept a fee, not just when they take in a retainer, he said.
On the other hand, most law firms that accept bitcoin probably convert it immediately anyway because the tax accounting is much simpler that way, Middlebrook said.
He noted that under IRS guidance on virtual currency, bitcoin is treated as property for federal tax purposes. Its basis must be tracked, and tracking requires knowing the value of the bitcoin when received and when sent. “Tracking it is a nightmare,” he said.
Middlebrook also said the Nebraska opinion could use some clarification in its discussion of escrow.
He noted that in general, there’s an ethical duty of safekeeping when a lawyer is holding property that belongs to a client. There’s an interesting question about about what triggers the ethics rule on safekeeping in regard to bitcoin, he said.
In regard to this question, Middlebrook mentioned the Uniform Regulation of Virtual Currency Businesses Act, which was approved in July. He’s an advisor to the Uniform Law Commission committee that drafted the act.
Middlebrook said that because there’s no way to possess bitcoin, the drafters of the act needed to come up with something other than possession as the trigger for obligations under the act. They settled on the concept of “control,” defined as unilateral ability to transact.
Middlebrook said the Nebraska opinion seems to assume that an escrow involving lawyers and clients would occur in the same way as an ordinary escrow arrangement, in which the client gives complete control of the funds over to the lawyer.
Bitcoin could be escrowed that way, but alternative approaches are possible through the use of multisignature technology, Middlebrook said.
One approach is where the transfer of bitcoin can happen only if both the attorney and client sign. Another alternative is a three-party escrow where two out of the three parties have to sign in order to make the transfer.
According to the Uniform Regulation of Virtual Currency Businesses Act, a lawyer wouldn’t have control over the bitcoin in a multisignature escrow arrangement, Middlebrook said. The Nebraska opinion doesn’t address this issue, he noted.
Wagster told Bloomberg BNA that his firm’s policy is to convert cryptocurrency immediately upon acceptance, as advised in the Nebraska opinion.
Frost Brown Todd has some additional policies not included in the Nebraska opinion, Wagster said. The firm accepts cryptocurrency only from clients that are corporations, not individuals, and only for noncriminal matters.
Also, the firm accepts cryptocurrency only for payment of legal services provided, not for retainers.
Wagner said he wasn’t suggesting there’s something wrong with firms that want to keep cryptocurrency as retainers. “Our firm’s policy is we don’t want to take that risk,” he said.
The Nebraska opinion said no per se rule prohibits payment of earned legal fees with “convertible virtual currency.”
However, lawyers must make sure the digital currency isn’t contraband, doesn’t reveal client secrets, and isn’t used in a money-laundering or tax avoidance scheme, it said.
The committee said lawyers must take reasonable security precautions when they receive client payments in bitcoin or share them on behalf of clients. The opinion suggested that reasonable methods could include:
The committee took the position that because digital currency often fluctuates in value, lawyers must value or convert bitcoins into U.S. dollars immediately upon receipt, using a payment processor, and credit the client’s account accordingly.
This step will protect the client against value fluctuations that could otherwise result in charging unreasonable fees contrary to Nebraska Rules of Professional Conduct §3-501.5, the panel said.
Lawyers should notify the client in advance, which they can do in the fee agreement, that they will convert payments immediately, the committee advised.
The committee also said lawyers who take bitcoins as payment from a third party for legal services to a client should use standard “know your client” procedures to identify the payer.
This step is necessary to enable lawyers to comply with the ethics rules on third-party fee arrangements ( Rule §3-501.8(f)), conflicts of interest ( Rule §3-501.7(a)), and lawyer-client confidentiality ( Rule 3-501.6), it said.
In addition, the committee said lawyers may hold bitcoin and other digital currency in escrow or trust for clients or third parties under Rule §3-501.15(a) (safekeeping property).
Lawyers should inform the client and other parties that the bitcoins will be held and not converted into U.S. dollars or other currency, the committee said. Lawyers must keep that notice for five years along with the records of the separate wallet used to store the bitcoins, it said.
The committee said that unless converted to U.S. dollars, bitcoins can’t be deposited in a client trust account created under Nebraska rules that set out trust fund requirements for lawyers.
Therefore, if a lawyer receives bitcoins intended to reflect a retainer to be drawn upon when fees are earned in the future, the lawyer must immediately convert the bitcoins into U.S. dollars, it said.
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