Digital/Virtual Currencies

BitcoinWith the April 17 deadline for filing individual tax returns just around the corner, individuals who engaged in cryptocurrency transactions during 2017 must take care to properly report them on their tax returns. As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase recently announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And most recently, on March 23, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.

Four years ago, the IRS issued its only guidance to date regarding its view of the tax treatment of cryptocurrency transactions. Despite the explosion of interest in cryptocurrencies (currently more than 1,500 such currencies exist) and the monumental increase in Bitcoin’s value last year (an uptick of more than 1,400 percent before year’s end), the IRS has not updated its views or issued further guidance to investors, thus leaving individuals scrambling to make sure that their 2017 tax returns are properly capturing cryptocurrency transactions. This is especially critical for investors who sold Bitcoin during its rocket-like trajectory last year.

The IRS considers cryptocurrency transactions taxable just like transactions in any other property, and general tax principles that apply to property transactions apply. As a consequence, the following rules apply:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

In an article published by Bloomberg today, Lily Katz and Lynnley Browning write that many investors, and even tax professionals, are struggling to properly report their cryptocurrency transactions on their 2017 tax returns, due to be filed in four days:

If you thought trading Bitcoin was wild, try figuring out how to pay taxes on it.

Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year’s boom in values, many people are likely disclosing transactions for the first time, adding to confusion.

The Bloomberg article further reports that the IRS is advising individuals to look for tax guidance in analogous areas:

An IRS spokesman said that in addition to the agency’s 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the “factual scenarios that most closely resemble their circumstances.”

Individuals who fail to properly report their cryptocurrency transactions can face harsh consequences, including civil audits, penalties, and even criminal prosecution, as the IRS warned in a recent press release reminding taxpayers to report such transactions:

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Despite the lack of up-to-date IRS guidance, and the uncertainly surrounding the tax consequences of recent developments in this area (such as “hard forks”), cryptocurrency investors would be well-advised to exercise caution with their income tax returns due next week.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinWith “tax day” fast approaching, the Internal Revenue Service on Friday reminded taxpayers that income from virtual currency transactions is reportable on their income tax returns. As we have previously reported, the IRS has for some time been focusing significant attention on tax compliance with respect to virtual currency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in virtual currency transactions during 2013-2015, and Coinbase recently announced that it would be disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of virtual currency transactions by assembling a team of specialized investigators in this area. With increased attention to virtual currency transactions, taxpayers who engaged in such transactions during 2017 must take care to ensure they are compliant with reporting obligations on their federal income tax returns.

The text of the IRS press release follows:

Virtual currency transactions are taxable by law just like transactions in any other property. The IRS has issued guidance in IRS Notice 2014-21 for use by taxpayers and their return preparers that addresses transactions in virtual currency, also known as digital currency.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are currently more than 1,500 known virtual currencies. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS.

Notice 2014-21 provides that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency. Among other things, this means that:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

The Wall Street Journal reports today that the Securities and Exchange Commission has recently issued multiple subpoenas and requests for information in a widening investigation of cryptocurrency firms.

According to the article, the subpoenas seek information about the structure for token sales and initial coin offerings:

The SEC scrutiny is focused in part on “simple agreements for future tokens,” or SAFTs, which are used in some of the most prominent crypto-fundraisings, according to people familiar with the matter.

The agreements allow big investors and relativity well-off individuals to buy rights to tokens ahead of their sale.  The rights can be traded, or flipped for profits, even before the sale begins.

The SEC is concerned that such agreements are potentially being used to trade like securities without conforming to the strict rules that apply to securities.

The SEC’s latest actions follow its creation last fall of a dedicated Cyber Unit to focus the Enforcement Division’s cyber-related expertise on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking, and threats to trading platforms.  In December, the SEC’s Cyber Unit filed its first-ever charges, obtaining an emergency asset freeze to halt a “fast-moving” ICO fraud that raised up to $15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month.  Several days later, the SEC announced that a California-based company selling digital tokens to investors to raise capital for its blockchain-based food review service halted its initial coin offering (ICO) and agreed to a cease-and-desist order in which the SEC found that its conduct constituted unregistered securities offers and sales.  Then in late January, the SEC announced that it has obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what was claimed to be the world’s first “decentralized bank” offering its own cryptocurrency.  In addition to these enforcement actions, the SEC’s Office of Investor Education and Advocacy has issued an Investor Alert warning investors about potential scams and frauds involving ICOs.

The Wall Street Journal article reports that Robert Cohen, head of the SEC’s Cyber Unit, said last week that at least one dozen companies have placed their ICOs on hold after the SEC raised questions.  The article further reports that coin offerings have already raised about $1.66 billion this year.  According to a forthcoming study of the ICO market by MIT, approximately $270 million to $317 million of the funds raised by ICOs have “likely going to fraud or scams.”

The Wall Street Journal article is available here (subscription required).

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinOn Friday, Coinbase, the largest U.S.-based Bitcoin exchange, notified approximately 13,000 of its customers that it would be turning over their account information to the Internal Revenue Service within 21 days.  This follows the decision by a federal court in November to uphold a “John Doe” summons issued by the IRS seeking such data from Coinbase due to concerns about tax non-compliance by Coinbase customers. In the Court’s ruling, Coinbase was ordered to hand over the following information for certain of its customers during the 2013-2015 time period: taxpayer ID, name, date of birth, address, and historical transaction records. As a result of this development, Individuals who are not tax-compliant with respect to their Coinbase holdings may need to take immediate remedial action to mitigate their potential civil and/or criminal exposure.

“John Doe” Summons to Coinbase

A “John Doe” summons is an information-gathering tool that is being used with increasing frequency by the IRS to obtain information and records about a class of unidentified taxpayers if the IRS has a reasonable belief that such taxpayers are engaged in conduct violating U.S. tax laws. Because the identities of the targeted taxpayers are unknown, the summons is denoted with a “John Doe” moniker. Expressly authorized by the Internal Revenue Code, a John Doe summons must first be approved by a federal judge before it can be served. The IRS sought to serve a summons on Coinbase because of its concern that the anonymous nature of virtual currencies like Bitcoin may allow users to engage in tax evasion and other illegal conduct:

Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are nearly a thousand virtual currencies, but the most widely known and largest is bitcoin. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, taxpayers may be using them to hide taxable income from the IRS.

In late 2016, a federal judge authorized the IRS to serve a “John Doe” summons on Coinbase seeking information about U.S. taxpayers who conducted transactions in virtual currency during 2013, 2014, and 2015. In court documents, the Justice Department stated that Coinbase was the fourth largest exchanger globally of Bitcoin and the largest exchanger in the United States. The Justice Department further stated that Coinbase offered buy/sell trading functionality in 32 countries, maintaining over 4.9 million wallets with wallet services available in 190 countries, serving 3.2 million customers, with $2.5 billion exchanged in Bitcoin. According to the IRS, only 2,500 taxpayers reported transactions in Bitcoin on their U.S. income tax returns during the three years in question, as compared to nearly 500,000 U.S. customers reported by Coinbase during the same period. Coinbase vigorously resisted the “John Doe” summons, and the matter has been in litigation for a full year before the court ruled in November that Coinbase had to comply.

Coinbase Customer Notification

Here is the text of the letter sent by Coinbase to its customers:

Subject: An important message from Coinbase

In December 2016, the Internal Revenue Service issued a summons demanding that Coinbase produce a wide range of records relating to approximately 500,000 Coinbase customers.  Coinbase fought this summons in court in an effort to protect its customers, and the industry as a whole, from unwarranted intrusions from the government. 

After a long process, the court issued an order that represents a partial, but still significant, victory for Coinbase and its customers: the order requires Coinbase to produce only certain limited categories of information from the accounts of approximately 13,000 customers. 

We are writing to let you know that the above-described court order requires us to produce information specific to your account.  

If you have concerns about this, we encourage you to seek legal advice from an attorney promptly. Coinbase expects to produce the information covered by the court’s order within 21 days.

For your reference, the court’s judgment can be found here. The case was filed in the United States District Court for the Northern District of California, Case No. 17-cv-01431-JSC. 

In addition, we also want you to know that because Coinbase received a summons on December 8, 2016, and more than six months passed before our challenges to the summons were resolved by the court, the period of limitations under sections 6501 and 6531 of the Internal Revenue Code (title 26 of the U.S. Code) were suspended beginning as of June 8, 2017 and continuing through the final resolution of Coinbase’s response to the summons. This may be relevant to the tax returns that you have filed for the 2013, 2014, and 2015 calendar years. If you have questions about your tax liability for those years, we strongly encourage you to consult with your tax advisor.

Regards,

The Coinbase Team

Once it receives the summoned data from Coinbase, the IRS will cross-check tax returns filed by the individuals in question to determine if they properly reported their Bitcoin trading gains and losses. Individuals who have not properly reported their Bitcoin holdings will likely be contacted by the IRS, and the nature of that contact will be dictated by the magnitude of each individual’s tax non-compliance. For Coinbase customers with a relatively small number of unreported transactions, the IRS may simply send a “soft” letter advising them to file amended tax returns. Coinbase users with a greater number of unreported transactions may be selected for audit and face penalties for not properly reporting Bitcoin transactions. The most egregious examples of non-compliance may well face criminal investigation by the IRS, if there is evidence those customers deliberately intended to evade their tax obligations by trading in Bitcoin. As we previously reported, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions, assembling a specialized team of criminal investigators to build criminal tax evasion cases involving users of Bitcoin and other cryptocurrencies.

Immediate Action May Be Necessary for Affected Coinbase Customers

For individuals whose Coinbase account information is about to be released to the IRS, immediate action may be necessary. While the IRS has not yet announced whether it will unveil a voluntary disclosure program for crytopcurrency (similar to the popular and well-publicized Offshore Voluntary Disclosure Program for foreign bank accounts), the IRS continues to maintain a traditional voluntary disclosure program pursuant to which individuals can mitigate potential criminal exposure by promptly self-disclosing their non-compliance. As with the OVDP, time is of the essence because the IRS can deny a voluntary disclosure application if the IRS already knows of the taxpayer’s non-compliance, such as through information received as a result of a “John Doe” summons. In the context of the OVDP, the IRS has published a specific FAQ addressing this very point:

Once the Service or the Department of Justice obtains information under a John Doe summons, treaty request, or other similar action that provides evidence of a specific taxpayer’s noncompliance with the tax laws or Title 31 reporting requirements, that particular taxpayer will become ineligible for OVDP and Criminal Investigation’s Voluntary Disclosure Practice. For this reason, a taxpayer concerned that a party subject to a John Doe summons, treaty request, or similar action will provide information about him to the Service should apply to make a voluntary disclosure as soon as possible.

The IRS can be expected to apply the same principle to taxpayers whose data is turned over by Coinbase. As a result, taxpayers with Coinbase accounts who wish to make a voluntary disclosure would be well-advised to do so before Coinbase hands over their account information to the IRS.

Impact on Statute of Limitations

Coinbase’s letter to its customers contains an important warning regarding suspension the statute of limitations.  The Internal Revenue Code imposes strict time limits for the IRS to audit a tax return or to file criminal charges regarding a filed return. Ordinarily, the IRS has three years to commence a civil audit of a tax return (subject to certain exceptions), and six years to bring criminal charges. Because Coinbase filed a legal challenge to the “John Doe” summons served by the IRS, and more than six months passed before that challenge was resolved by the court, the applicable statutes of limitation were suspended for at least six months.  This means that the IRS has additional time to audit or investigate the 13,000 taxpayers whose data is being turned over to the IRS.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinIn a recent speech, the Under Secretary of Treasury’s Office of Terrorism and Financial Intelligence (TFI) warned of the growing threats to the U.S. financial system posed by virtual currencies. Addressing the Securities Industry and Financial Markets Association’s Anti-Money Laundering & Financial Crimes Conference, Sigal Mandelker spoke broadly of the U.S. government’s efforts to combat money laundering, terrorist financing, narcotics trafficking, corruption, and other types of illicit finance and national security threats.

In her speech, Under Secretary Mandelker specifically focused on ways in which criminals and other illicit actors are now using virtual currencies:

Kleptocrats and criminals are also attempting to find new ways around our controls to exploit the financial system. In recent years, we’ve seen terrorist groups, criminal organizations, and even rogue regimes like Venezuela experiment with and use digital and virtual currencies to hide their ill-gotten gains and finance their illicit activities. Recently, for example, Venezuela announced plans to create the “petro” digital currency to try and sidestep our powerful sanctions, which the United States imposed on the regime for its vicious assault on human rights and the rule of law.

Likewise, law enforcement authorities recently arrested a woman in New York who used Bitcoin to launder fraud proceeds before wiring the money to ISIS.

In TFI, we closely track technological innovations involving virtual currency and are aggressively targeting rogue actors attempting to use it for illicit purposes. Critical to our efforts is the regulatory framework and enforcement authorities we have in place that govern the use of virtual currency. Through FinCEN, Treasury regulates virtual currency exchangers as money transmitters and requires them to abide by Bank Secrecy Act obligations. We also use our strong enforcement powers to target those who fail to live up to their responsibilities.

Virtual currency businesses are subject to comprehensive, routine AML/CFT examinations, just like financial institutions in the securities and futures markets. We work in partnership with the IRS to examine virtual currency exchangers under our regulations for money transmitters. We also work in partnership with the SEC and CFTC to ensure that these businesses and those in your sector dealing in virtual currency appropriately address their AML/CFT BSA responsibilities.

We are also encouraging our international partners to strengthen their virtual currency frameworks. The lack of AML/CFT regulation of virtual currency providers worldwide greatly exacerbates virtual currency’s illicit financing risks. Currently, we are one of the only major countries in the world, along with Japan and Australia, that regulate these activities for AML/CFT purposes. But we need many more countries to follow suit, and have made this a priority in our international outreach, including through the Financial Action Task Force.

North Korea, Hizballah, Iran, and emerging technologies used by illicit actors are just a few examples of the many threats we face. They reinforce the importance of the international community coming together to combat bad actors and protect financial systems, markets, and institutions from abuse.

Under Secretary Mandelker also spoke about the critically important role of anti-money laundering compliance in the financial industry, and warned that “companies and individuals who do not adhere to our laws face stiff penalties,” noting that “[a]ggressive enforcement gives teeth to our powerful economic authorities.” She further explained that the financial industry must carefully study, and learn from, the enforcement actions taken by FinCEN and other Treasury departments:

Each of our actions, whether by FinCEN, OFAC, or other departments, provides an opportunity for the private sector to gain better insight into our compliance and enforcement priorities, and each action tells a story about our expectations and where that particular company fell short.

She then described FinCEN’s well-publicized enforcement action against BTC-e, a foreign virtual currency exchanger:

In the last year we have pursued actions against a number of non-U.S. companies and individuals for violating U.S. laws related to economic sanctions and money laundering, sending the very powerful message that we are intent on using our authorities no matter where in the world the illicit activity is taking place.

For example, FinCEN recently assessed a $110 million fine against BTC-e, an Internet-based virtual currency exchanger located outside the United States which did substantial business in our country. BTC-e exchanges fiat currency, as well as convertible currencies like Bitcoin and Ethereum, at one point serving approximately 700,000 customers across the world and associated with bitcoin wallets that have received over 9.4 million bitcoins.

Customers located within the United States used BTC-e to conduct tens of thousands of transactions worth hundreds of millions of dollars in virtual currencies, including between customers located in the U.S.

Yet BTC-e never registered as a money transmitter, even after FinCEN made clear through published advisories and other guidance that such exchangers were legally required to do so.

The company lacked basic controls to prevent the use of its services for illicit purposes.

As a result, they emerged as one of the principal means by which cyber criminals around the world laundered the proceeds of their illicit activity, facilitating crimes such as computer hacking and ransomware, fraud, identity theft, tax refund schemes, public corruption and drug trafficking.

In light of BTC-e’s failure to fulfill its AML obligations, Treasury took action both against the company and Russian national Alexander Vinnik, who directed and supervised BTC-e’s operations and finances.

We imposed a $12 million penalty on Vinnik and the Justice Department indicted him on 21 counts.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinThe Internal Revenue Service has assembled a specialized team of criminal investigators to build criminal tax evasion cases involving users of Bitcoin and other cryptocurrencies, according to a Bloomberg article entitled “IRS Cops Are Scouring Crypto Accounts to Build Tax Evasion Cases.” In that article, David Voreacos writes that IRS Special Agents are pivoting from investigating taxpayers with secret offshore bank accounts to taxpayers with cryptocurrency accounts. Don Fort, chief of the IRS Criminal Investigation Division (IRS-CI), is quoted as saying that “It’s possible to use Bitcoin and other cryptocurrencies in the same fashion as foreign bank accounts to facilitate tax evasion.”

Last fall, IRS-CI announced that it was creating a new international tax enforcement group to focus on investigating and building criminal cases involving cross-border activity. According to the Bloomberg article, a newly-assembled team of 10 special agents in that group are now focusing not only on international crimes but also potential tax evasion using cryptocurrency.

As we have previously reported (here, here, and here), other federal agencies are tightening the regulatory framework surrounding cryptocurrencies and are launching vigorous enforcement campaigns to crackdown on fraud. Both the Securities and Exchange Commission and Commodity Futures Trading Commission have formed specialized enforcement groups to focus on cryptocurrency fraud, and have issued stern warnings to investors and consumers about the risks of cryptocurrency investments.

Last fall, the Internal Revenue Service has prevailed in its long-running dispute with Coinbase, the largest U.S.-based Bitcoin exchange, with a federal judge ordering Coinbase to comply with a “John Doe” summons seeking customer information. In an opinion issued on November 28, 2017, the court in San Francisco found that the government’s narrowed request for information on Coinbase’s customers served the legitimate purpose of investigating whether Bitcoin users properly reported gains or losses on their income tax returns. The Court also found that the customer records sought by the government were relevant because they can be used by the IRS to determine whether a particular Coinbase customer is tax compliant. Coinbase must now hand over to the IRS records for accounts that had at least one transaction of at least $20,000 value during the period 2013 to 2015. According to Coinbase, this will require it to divulge trading records regarding nearly 9 million transactions conducted by over 14,000 customers.

Notwithstanding all of this enforcement activity, early data from federal tax filing season (which began January 29, 2018) suggests that cryptocurrency investors may not be properly reporting gains/losses on their 2017 federal income tax returns. Reuters reported yesterday on preliminary tax filing data from online tax service Credit Karma:

Less than 100 people out of the 250,000 individuals who have already filed federal taxes this year through company Credit Karma reported a cryptocurrency transaction to U.S. tax authorities, the company said on Tuesday.

This is despite nearly 57 percent of the 2000 Americans surveyed by the credit score startup and research firm Qualtrics last month saying they had realized some gains from cryptocurrencies, according to a Credit Karma study.

Roughly the same percentage said they had never reported cryptocurrency gains to the Internal Revenue Service, while nearly half of those polled said they understood how owning cryptocurrencies affected their taxes, the study said.

The IRS considers cryptocurrencies such as bitcoin as property for federal tax purposes, meaning any profits or losses from the sale or exchange of the virtual coins should generally be reported as capital gains or losses.

Trading of cryptocurrencies, digital tokens whose value is not backed by central banks and hard assets, surged in 2017 amid a rally in their price. A single bitcoin is worth more than $8000, compared with $1000 a year ago.

Despite the surge it remains unclear how many Americans hold cryptocurrencies as these are bought and sold on online platforms, sometimes anonymously or using pseudonyms. US-based cryptocurrency exchange Coinbase says it has 10 million users, although it is unclear how many of these are in the U.S.

Jagjit Chawla, general manager for Credit Karma Tax said the company was not too surprised that few people had reported cryptocurrency gains as Americans with more complex tax situations tend to file closer to the deadline.

“However, given the popularity of bitcoin and cryptocurrencies in 2017, we’d expect more people to be reporting,” Chawla said in a statement.

Credit Karma entered the online tax filing market last year, and about 1 million individuals filed their tax returns using Credit Karma’s product.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Our colleagues Joshua Horn, Ernest E. Badway, and Benjamin H. McCoy have published an article about the recent release by the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations of its 2018 examination priorities, an annual report outlining the areas of the securities industry its examiners will target. This year, the priorities are organized into five broad areas:

  • Compliance and risks in critical market infrastructure
  • Retail investors
  • FINRA and MSRB
  • Cybersecurity
  • Anti-money laundering programs

The priorities also deal with recent hot-button developments in cryptocurrency and initial coin offerings, which we have written about previously (see prior coverage herehere, and here) . Firms should review the 2018 priorities and ensure that internal controls and practices are updated to effectively handle priority risks. You can read their article here.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinOver the course of the last two months, we have witnessed a flurry of enforcement activity with respect to initial coin offerings and virtual currency fraud schemes by the Securities and Exchange Commission and the Commodity Futures Trading Commission. The SEC continued that trend today with an announcement that it has obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what was claimed to be the world’s first “decentralized bank” offering its own cryptocurrency. The public sale in question began around December 26, 2017, and was originally scheduled to conclude on January 27, 2018, with distribution to investors on February 10, 2018.

According to the SEC’s complaint, filed in federal district court in Dallas on January 25 and unsealed late yesterday, Dallas-based AriseBank used social media, a celebrity endorsement, and other tactics to raise what it claims to be $600 million of its $1 billion goal in just two months. AriseBank and its two co-founders allegedly offered and sold unregistered investments in their “AriseCoin” cryptocurrency by depicting AriseBank as a first-of-its-kind decentralized bank offering a variety of consumer-facing banking products and services using more than 700 different virtual currencies.  AriseBank’s sales pitch claimed that it developed an algorithmic trading application that automatically trades in various cryptocurrencies.

The SEC alleges that AriseBank falsely stated that it purchased an FDIC-insured bank which enabled it to offer customers FDIC-insured accounts and that it also offered customers the ability to obtain an AriseBank-branded VISA card to spend any of the 700-plus cryptocurrencies.  AriseBank also allegedly omitted to disclose the criminal background of key executives.

The district court approved an emergency asset freeze over AriseBank and its two co-founders, and appointed a receiver over AriseBank, including over its digital assets.  The court-appointed receiver was able to immediately secure various cryptocurrencies held by AriseBank including Bitcoin, Litecoin, Bitshares, Dogecoin, and BitUSD.  The SEC seeks preliminary and permanent injunctions, disgorgement of ill-gotten gains plus interest and penalties, and bars against the individuals to prohibit them from serving as officers or directors of a public company or offering digital securities again in the future.

Today’s announcement from the SEC is the latest foray in an aggressive federal crackdown on virtual currency scams that has been underway since last fall. Both the SEC and CFTC have created specialized units to focus on virtual currency issues. The SEC’s Cyber Unit was created in September 2017 to focus the Enforcement Division’s cyber-related expertise on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking, and threats to trading platforms. The CFTC has created a Virtual Currency Task Force to focus on virtual currency fraud schemes.

The SEC’s Cyber Unit filed its first-ever suit to halt an ICO scam in early December (coverage here). Shortly thereafter, the SEC announced that it had obtained a cease-and-desist order to halt a California company’s ICO (coverage here).

Earlier this month, the CFTC weighed in, announcing the filing of two enforcement actions to combat alleged virtual currency fraud schemes (coverage here). The next day, the CFTC and SEC issued a joint statement reaffirming their agencies’ commitment to continuing to address violations and to bringing legal actions to stop and prevent fraud in the offer and sale of digital instruments. Most recently, the CFTC filed suit on January 24 to halt an alleged virtual currency scam involving a currency called My Big Coin (coverage here).

In addition to these enforcement actions, the SEC and CFTC have published guidance warning consumers and investors as to the perils of ICOs and virtual currency schemes. The SEC’s Office of Investor Education and Advocacy issued an Investor Alert in August 2017. In December 2017, the CFTC launched its Virtual Currency Resource Web Page and published a Customer Advisory to inform the public of possible risks associated with investing or speculating in virtual currencies.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Last week we reported on a flurry of enforcement activity by the Commodities Futures Trading Commission’s “Virtual Currency Task Force” with respect to virtual currency fraud schemes. On Thursday, January 18, the CFTC filed two lawsuits in federal court in New York seeking to shut down two such schemes and to recover funds for victimized investors. The first suit charged a New York resident and his New York-based company with fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin. The second suit charged a Colorado resident and his United Kingdom-registered company with a Ponzi-style scheme involving the solicitation of Bitcoin from investors to be pooled and invested in products including binary options. The following day, the Directors of Enforcement for both the CFTC and the Securities and Exchange Commission issued a joint statement reaffirming their agencies’ commitment to address violations and to bring actions to stop and prevent fraud in the offer and sale of digital instruments.

Continuing its crackdown on virtual currency fraud, the CFTC today announced the filing of another enforcement action charging commodity fraud and misappropriation related to the ongoing solicitation of customers for a virtual currency known as My Big Coin (MBC). The CFTC Complaint charges Randall Crater of East Hampton, New York, Mark Gillespie of Hartland, Michigan, and My Big Coin Pay, Inc., a corporation based in Las Vegas, Nevada, with misappropriating over $6 million from customers by, among other things, transferring customer funds into personal bank accounts, and using those funds for personal expenses and the purchase of luxury goods.

The suit was filed on January 16, 2018, under seal, in federal court in Massachusetts. On that same day, the Court issued a temporary restraining order, also under seal, freezing the defendants’ assets. The restraining order also freezes the assets of multiple relief defendants for allegedly receiving customer funds without providing any legitimate services to clients and without any interest or entitlement to such customer funds. The Court’s restraining order also prohibits the defendants and relief defendants from destroying or altering books and records.

The CFTC’s complaint alleges that from at least January 2014 through January 2018, the defendants fraudulently solicited potential and existing MBC customers throughout the United States by making false and misleading claims and omissions about MBC’s value, usage, and trade status, and that MBC was backed by gold. The defendants are also alleged to have fraudulently solicited numerous customers in Massachusetts, receiving in excess of $5 million from those customers.

As alleged in the complaint, the MBC website, maintained and operated by the defendants, conveyed to customers numerous solicitation materials, MBC trade data, and other materials (1) misrepresenting that MBC was actively being traded on several currency exchanges, including the MBC Exchange website, when in fact it was not; (2) misrepresenting in reports the daily trading price, when in fact no price existed because MBC was not trading; (3) misrepresenting that MBC was backed by gold, when in fact it was not; and (4) misrepresenting that MBC had partnered with MasterCard, with the promise that MBC could be used anywhere MasterCard was accepted, when in fact no such partnership existed and MBC could not be used anywhere MasterCard was accepted. In reality, as alleged, the supposed trading results were illusory, and any payouts to customers were derived from funds fraudulently obtained from other customers in the manner of a Ponzi scheme.

As customers began to raise questions about their MBC accounts, the complaint alleges that the defendants attempted to conceal their fraud by issuing additional coins to customers and falsely representing that they had secured a deal with another exchange to trade MBC. The defendants allegedly encouraged customers to refrain from redeeming their MBC holdings until MBC was active on this “new” exchange.

The CFTC alleges that the defendants misappropriated virtually all of the approximately $6 million they solicited from customers, using these funds to purchase a home, antiques, fine art, jewelry, luxury goods, furniture, interior decorating and other home improvement services, travel, and entertainment.

In the litigation, the CFTC seeks civil monetary penalties, restitution, rescission, disgorgement of ill-gotten gains, trading and registration bans, and permanent injunctions against further violations of the federal commodities laws, as charged.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Bitcoin

Yesterday the Commodity Futures Trading Commission announced two enforcement actions as part of a continuing crackdown on virtual currency fraud schemes by numerous federal agencies. (We have previously written about the Securities and Exchange Commission’s efforts in this area here and here.)  And today the CFTC and SEC issued a joint statement reaffirming their agencies’ commitment to continuing to address violations and to bringing legal actions to stop and prevent fraud in the offer and sale of digital instruments.

Patrick K. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets

The CFTC announced the filling of a federal civil enforcement action in the U.S. District Court for the Eastern District of New York against Patrick K. McDonnell, of Staten Island, New York, and CabbageTech, Corp. d/b/a Coin Drop Markets (CDM), a New York corporation, charging them with fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin.

The CFTC’s Complaint alleges that from approximately January 2017 to the present, McDonnell and CDM engaged in a deceptive and fraudulent virtual currency scheme to induce customers to send money and virtual currencies to CDM, purportedly in exchange for real-time virtual currency trading advice and for virtual currency purchasing and trading on behalf of the customers under McDonnell’s direction. In fact, as charged in the CFTC Complaint, the supposedly expert, real-time virtual currency advice was never provided, and customers who provided funds to McDonnell and CDM to purchase or trade on their behalf never saw those funds again. In short, according to the CFTC, McDonnell and CDM used their fraudulent solicitations to obtain and then simply misappropriate customer funds.

The CFTC Complaint further alleges that to conceal their scheme, soon after obtaining customer funds, Defendants removed the website and social media materials from the Internet and ceased communicating with CDM Customers, who lost most if not all of their invested funds due to Defendants’ fraud and misappropriation. The CFTC Complaint also alleges that neither Defendant has ever been registered with the CFTC in any capacity.

In its continuing civil litigation, the CFTC seeks, among other relief, restitution to defrauded customers, disgorgement of benefits from violations of the Commodity Exchange Act and CFTC Regulations, civil monetary penalties, trading bans, and a permanent injunction against future violations of federal commodities laws, as charged.

Dillon Michael Dean and The Entrepreuneurs Headquarters Limited

The CFTC also announced the filing of a civil enforcement action in the U.S. District Court for the Eastern District of New York against Dillon Michael Dean of Longmont, Colorado, and his company, The Entrepreneurs Headquarters Limited, a UK-registered company. The CFTC Complaint charges the Defendants with engaging in a fraudulent scheme to solicit Bitcoin from members of the public, misrepresenting that customers’ funds would be pooled and invested in products including binary options, making Ponzi-style payments to commodity pool participants from other participants’ funds, misappropriating pool participants’ funds, and failing to register with the CFTC as a Commodity Pool Operator (CPO) and Associated Person of a CPO, as required.

Specifically, the Complaint alleges that, from approximately April 2017 through the present, Defendants, who have never been registered with the CFTC in any capacity, have engaged in a fraudulent scheme through which they solicited at least $1.1 million worth of Bitcoin from more than 600 members of the public. Defendants allegedly promised to convert this Bitcoin into fiat currency to invest on the customers’ behalf in a pooled investment vehicle for trading commodity interests, including trading binary options on an online exchange designated as a contract market by the CFTC. Potential pool participants were solicited to invest with Defendants by false claims of trading expertise and promises of high rates of return. The Complaint further alleges that, rather than convert customers’ Bitcoin to fiat currency to invest in binary options contracts, as promised, Defendants misappropriated their customers’ funds, including by using the funds to pay other customers, in the manner of a Ponzi scheme.

The Complaint alleges that Defendants solicited customer deposits using company websites, YouTube videos, and Facebook posts, where Defendants claimed that customers’ funds would be pooled and invested in commodity options on behalf of customers, that Dean had “strong skills” in options trading, and that Defendants were generating high rates of return through trading commodity options, among other false claims. But, as alleged, Defendants were not actually engaged in trading on behalf of their customers, and Defendants’ purported trading profits were fictitious. As alleged in the Complaint, Defendants stopped making payments to their customers, having misappropriated over $1 million in customers’ funds, while Dean has launched another similar purported trading venture under the name Real Trade Profits, using a website to solicit customers to deposit Bitcoin for a pooled investment in binary options trading and promising high rates of return.

In its ongoing litigation, the CFTC seeks restitution to defrauded persons, disgorgement of ill-gotten gains, civil monetary penalties, permanent trading and registration bans, and a permanent injunction against further violations of the Commodity Exchange Act and CFTC Regulations, as charged.

Joint statement from CFTC and SEC Regarding Virtual Currency Enforcement Actions

Today the following joint statement was issued by CFTC Enforcement Director James McDonald and SEC Enforcement Co-Directors Stephanie Avakian and Steven Peikin:

When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws.

The Divisions of Enforcement for the SEC and CFTC will continue to address violations and to bring actions to stop and prevent fraud in the offer and sale of digital instruments.

CFTC’s Customer Fraud Advisory on Virtual Currencies and Bitcoin

The CFTC has issued a Customer Advisory on the Risks of Virtual Currency Trading to inform the public of possible risks associated with investing or speculating in virtual currencies or recently launched Bitcoin futures and options.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.