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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.

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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 here, here, 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.

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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.

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BitcoinThe Securities and Exchange Commission announced yesterday 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.

According to the SEC’s order, before any tokens were delivered to investors, Munchee Inc. refunded investor proceeds after the SEC intervened.  Munchee was seeking $15 million in capital to improve an existing iPhone app centered on restaurant meal reviews and create an “ecosystem” in which Munchee and others would buy and sell goods and services using the tokens.  The company communicated through its website, a white paper, and other means that it would use the proceeds to create the ecosystem, including eventually paying users in tokens for writing food reviews and selling both advertising to restaurants and “in-app” purchases to app users in exchange for tokens.

According to the cease-and-desist order, in the course of the offering, the company and other promoters emphasized that investors could expect that efforts by the company and others would lead to an increase in value of the tokens.  The company also emphasized it would take steps to create and support a secondary market for the tokens.  Because of these and other company activities, investors would have had a reasonable belief that their investment in tokens could generate a return on their investment.  Munchee consented to the SEC’s cease-and-desist order without admitting or denying the findings.

As the SEC has said in the DAO Report of Investigation, a token can be a security based on the long-standing facts and circumstances test that includes assessing whether investors’ profits are to be derived from the managerial and entrepreneurial efforts of others.

“We will continue to scrutinize the market vigilantly for improper offerings that seek to sell securities to the general public without the required registration or exemption,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.  “In deciding not to impose a penalty, the Commission recognized that the company stopped the ICO quickly, immediately returned the proceeds before issuing tokens, and cooperated with the investigation.”

“Our primary focus remains investor protection and making sure that investors are being offered investment opportunities with all the information and disclosures required under the federal securities laws,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division.

The SEC’s new Cyber Unit is focused on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, brokerage account takeovers, hacking to obtain nonpublic information, and threats to trading platforms.  We previously reported on the Cyber Unit’s first action, filed last week, to halt an alleged ICO scam. The SEC also has a Distributed Ledger Technology Working Group that focuses on various emerging applications of distributed ledger technology in the financial industry. The SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin in July 2017 to make investors aware of the potential risks of participating in initial coin offerings.

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BitcoinThe Securities and Exchange Commission announced yesterday that its new Cyber Unit obtained an emergency asset freeze to halt a “fast-moving” Initial Coin Offering (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.

The SEC filed charges against what it calls a “recidivist Quebec securities law violator” named Dominic Lacroix, and his company, PlexCorps. The complaint, filed in federal court in Brooklyn, alleges that Lacroix and PlexCorps marketed and sold securities called PlexCoin on the internet to investors in the U.S. and elsewhere, claiming that investments in PlexCoin would yield a 1,354 percent profit in less than 29 days. The SEC also charged Lacroix’s partner, Sabrina Paradis-Royer, in connection with the scheme. Based on its filing, the SEC obtained an emergency court order to freeze the assets of PlexCorps, Lacroix, and Paradis-Royer.

The charges are the first filed by the SEC’s new Cyber Unit, which was created in September 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.

“This first Cyber Unit case hits all of the characteristics of a full-fledged cyber scam and is exactly the kind of misconduct the unit will be pursuing,” said Robert Cohen, Chief of the Cyber Unit. “We acted quickly to protect retail investors from this initial coin offering’s false promises.”

The SEC’s complaint charges Lacroix, Paradis-Royer and PlexCorps with violating the anti-fraud provisions, and Lacroix and PlexCorps with violating the registration provision, of the U.S. federal securities laws. The complaint seeks permanent injunctions and disgorgement plus interest and penalties. For Lacroix, the SEC also seeks an officer-and-director bar and a bar from offering digital securities against Lacroix and Paradis-Royer.

The SEC’s Office of Investor Education and Advocacy has issued several warnings to investors about scams of companies claiming to be engaging in initial coin offerings. In an Investor Bulletin published in July 2017, the SEC announced that in the context of ICOs, virtual coins or tokens that are offered or sold may be securities, and if they are securities, the offer and sale of these virtual coins or tokens in an ICO is subject to the federal securities laws:

Virtual coins or tokens are created and disseminated using distributed ledger or blockchain technology. Recently promoters have been selling virtual coins or tokens in ICOs. Purchasers may use fiat currency (e.g., U.S. dollars) or virtual currencies to buy these virtual coins or tokens. Promoters may tell purchasers that the capital raised from the sales will be used to fund development of a digital platform, software, or other projects and that the virtual tokens or coins may be used to access the platform, use the software, or otherwise participate in the project. Some promoters and initial sellers may lead buyers of the virtual coins or tokens to expect a return on their investment or to participate in a share of the returns provided by the project. After they are issued, the virtual coins or tokens may be resold to others in a secondary market on virtual currency exchanges or other platforms.

In an Investor Alert from August 2017, the SEC specifically warned that “[f]raudsters often try to use the lure of new and emerging technologies to convince potential victims to invest their money in scams. These frauds include ‘pump-and-dump’ and market manipulation schemes involving publicly traded companies that claim to provide exposure to these new technologies.”