On July 18, FinCEN published SAR Stats—formerly called By the Numbers—an annual compilation of numerical data gathered from the Suspicious Activity Reports (SARs) filed by financial institutions using FinCEN’s new unified SAR form and e-filing process. Among other things, the new form and process were designed to allow FinCEN to collect more detailed information on types of suspicious activity. As such, FinCEN describes the data presented in this first SAR Stats issue as “a new baseline for financial sector reporting on suspicious activity.” The primary purpose of the report is to provide a statistical overview of suspicious activity developments, including by presenting SAR data arranged by filing industry type for the more than 1.3 million unique SARs filed between March 1, 2012 and December 31, 2013. In addition, the redesigned annual publication includes a new SAR Narrative Spotlight, which focuses on “perceived key emerging activity trends derived from analysis of SAR narratives.” The inaugural Spotlight examines the emerging trend of Bitcoin related activities within SAR narrative data. It states that FinCEN is observing a rise in the number of SARs flagging virtual currencies as a component of suspicious activity, and provides for potential SAR filers an explanation of virtual currencies and the importance of SAR data in assessing virtual currency transactions.
The New York Department of Financial Services riveted the attention of the virtual currency world (and just about everyone else involved with digital financial services), with its July 17 proposal to issue licenses for Virtual Currency Business Activities. The so-called BitLicense proposal features broad coverage; open ended capital and bonding requirements; personal investigation of founders, investors and even employees; and prior regulatory approval of new products and activities.
These and other aspects of BitLicensing beg the question: will licensing protect the public and investors? Or just drive Bitcoin participants out? (If they leave, they may find roadblocks elsewhere; days before New York’s announcement, France’s Ministry for the Economy and Finance, for example, proposed regulating Bitcoin.) Opportunistic locales for virtual currency operators are already being identified, such as the Isle of Man, a self-governing British Crown Dependency, whose Financial Supervision Commission says it is “not the appropriate time” to introduce a regulatory regime, while warning there is no consumer protection in the digital currency market. Think about this: Tiny Delaware is a corporate legal haven, Switzerland created an international bank haven, and a virtual currency haven may be next. Regulatory exercises like New York’s could advance that option. Read more…
On July 17, the New York DFS announced a proposal to establish a licensing regime for virtual currency businesses, the first by any state. In January, the DFS held a two-day hearing on developing a regulatory framework for virtual currency firms, and subsequently sought applications for virtual currency exchanges pending completion of the regulations. The proposed regulations define virtual currency as “any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology.” This would include digital units of exchange that: (i) have a centralized repository or administrator; (ii) are decentralized and have no centralized repository or administrator; or (iii) may be created or obtained by computing or manufacturing effort. It would exclude digital units that are used solely within online gaming platforms or that are used exclusively as part of a customer affinity or rewards program.
Under the proposal, the state would require companies engaged in the following activities to obtain a so-called BitLicense: (i) receiving or transmitting virtual currency on behalf of consumers; (ii) securing, storing, or maintaining custody or control of such virtual currency on the behalf of customers; (iii) performing retail conversion services; (iv) buying and selling virtual currency as a customer business (as distinct from personal use); or (v) controlling, administering, or issuing a virtual currency. To obtain a license, a business would be required to, among other things: (i) hold virtual currency of the same type and amount as any virtual currency owed or obligated to a third party; (ii) provide transaction receipts with certain required information; (iii) comply with AML rules; (iv) maintain a cyber security program; and (v) establish business continuity and disaster recovery policies. Licensed entities would be subject to DFS supervision, with examinations taking place no less than once every two calendar years. The proposal will be published in the New York State Register’s July 23, 2014 edition, which begins a 45-day public comment period.
On June 28, California Governor Jerry Brown signed AB 129, which repeals a state ban on the issuance or circulation of anything but lawful money of the United States. As described in a legislative staff analysis of the bill, the repeal is designed to ensure that forms of alternative currency such as digital currency, points, coupons, or other objects of monetary value do not violate the law when those methods are used for the purchase of goods and services or the transmission of payments in California.
On July 4, the European Banking Authority (EBA) released an Opinion that outlines for the EU Council, the European Commission, and the European Parliament requirements that would be needed to regulate virtual currencies. The EBA identified more than 70 risks across several categories and numerous causal drivers for those risks, including that (i) a virtual currency scheme can be created, and then its function subsequently changed, by anyone, and in the case of decentralized schemes, by anyone with a sufficient share of computational power; (ii) payer and payee can remain anonymous; (iii) virtual currency schemes do not respect jurisdictional boundaries and may therefore undermine financial sanctions and seizure of assets; and (iv) market participants lack sound corporate governance arrangements. To address those drivers, the EBA believes a regulatory framework would need to comprise, among other elements: (i) governance requirements for certain market participants; (ii) segregation of client accounts; (iii) capital requirements; and (iv) the creation of “scheme governing authorities” accountable for the integrity of a virtual currency scheme and its key components, including its protocol and transaction ledge. Given that the creation of such a regulatory framework will take time, the EBA recommends that European national prudential regulators take action in the immediate term to discourage financial institutions from buying, holding or selling virtual currencies while no regulatory regime is in place. In addition, the EBA recommends that EU legislators consider declaring market participants at the direct interface between conventional and virtual currencies, such as virtual currency exchanges, to become “obliged entities” under the EU Anti Money Laundering Directive and thus subject to its anti-money laundering and counter terrorist financing requirements. The EBA report follows a recent reportby the inter-governmental Financial Action Task Force (FATF) that provides an overview of virtual currency terms, markets, risks, and law enforcement actions announced to date.
As legal advisors to providers in the digital world, we are always thinking about regulation – whether it is coming, when it is coming, and what it will mean for our clients. After all, it is our mission to keep you on the safe side of the law, so you can create, succeed and prosper. With this in mind, we find the explosion of digital products and the warp-speed at which complex applications are emerging to be both a testament to irrepressible innovation and cause for concern. A recent Op-Ed in the Wall Street Journal (L. Gordon Crovitz, “Uber Shocks the Regulators,” June 16, 2014) notes “permissionless” digital innovation is upsetting traditional regulatory processes. The uber-popular Uber car service demonstrates that traditional taxi regulations are giving way to customer demands. The “old way” of making rules in response to existing providers may be faltering in an era of customer-driven preferences. If so, a sea change in the regulatory function may be looming. Read more…
On June 27, the GAO released a May 2014 report regarding virtual currency. The leaders of the Senate Homeland Security and Governmental Affairs Committee asked the GAO to examine potential policy issues related to virtual currencies and the status of federal agency collaboration in this area. The report summarizes virtual currency policy developments to date, and provides an overview of various interagency working groups and the ways each has so far addressed virtual currencies. The GAO concludes that consumer protection issues have largely not been addressed by the working groups, and recommends that the CFPB identify and join existing interagency working groups to ensure that consumer protection issues are considered as those groups develop virtual currency policies. In response to the report, the CFPB stated that it has been doing its own work on virtual currency, and has collaborated informally, but agreed that it should participate formally in interagency working groups.
On June 23, the ICBA and The Clearing House published a white paper on virtual currency that (i) defines virtual currency and describes the current regulatory environment; (ii) describes key players in the Bitcoin system; (iii) discusses the application of certain functional and prudential payment system regulations that may be applied to the Bitcoin system and other convertible decentralized virtual currencies; and (iv) evaluates potential regulation of virtual currency, virtual currency investment programs, and exchanges. The paper concludes, among other things, that: (i) credentials used to transact in Bitcoin are functionally similar to prepaid cards and arguably fall within the definition of such cards provided in Regulations E and II; and (ii) the CFPB may determine that cross-border transactions in Bitcoin fall within the scope of the CFPB’s Remittance Transfer Rule, which would require entities facilitating such transfers to comply with the rule’s disclosure, reversibility, and error-resolution requirements. The paper discusses potential safety and soundness oversight for entities in the Bitcoin system. It also suggests that existing regulations intended to protect consumers and market participants in the event of the failure of a securities or commodities exchange may be inapplicable to Bitcoin exchanges, and that alternative means of protecting investors and accountholders—such as disclosure requirements and coordinated state-level registration of exchanges—should be explored.
On June 6, the Kansas Office of State Bank Commissioner (OSBC) issued guidance on the regulatory treatment of virtual currencies under the Kansas Money Transmitter Act (KMTA). The guidance focuses on money transmission activities involving decentralized cryptocurrencies, such as Bitcoin. The guidance states that cryptocurrencies in their current form are not covered by the KMTA because they do not fall within the definition of “money”—no cryptocurrency is currently authorized or adopted by any governmental entity as part of its currency—or “monetary value”—there is no recognized standard of value or set value for a single unit of a cryptocurrency. The guidance explains that since the KMTA does not apply to transmission of decentralized cryptocurrencies, an entity engaged solely in the transmission of such currency is not required to obtain a money transmitter license. The guidance adds that, if transmission of virtual currency includes the involvement of sovereign currency in a transaction, it may be considered money transmission depending on how the transaction is organized. The guidance provides several examples of common types of transactions involving cryptocurrency and whether the KMTA applies to each, and outlines for cryptocurrency businesses that conduct money transmission, and entities engaged in money transmission, actions necessary to comply with state law, including licensing.
Minnesota Appellate Court Holds Email Signature Not Necessarily Evidence Of Intent To Sign Attachments
On June 2, the Minnesota Court of Appeals held that under the Uniform Electronic Transaction Act (UETA), an electronic signature in an email message does not necessarily evidence intent to electronically sign an attached document, and that whether the sender has electronically signed the attachment is dependent on certain facts and circumstances. SN4, LLC v. Anchor Bank, No. A13-1566, 2014 WL 2441343 (Minn. Ct. App., Jun. 2, 2014). A multifamily real estate purchaser sued a bank after negotiations between the parties over the sale of two properties held by the bank fell through. The purchaser claimed that the bank breached its contract by refusing to sell at a price the purchaser claims was established through a series of emails between the parties. The trial court rejected the buyers’ argument that the bank electronically subscribed to the agreement under the UETA and held that the purported agreement did not satisfy the statute of frauds because only the buyers subscribed to it. The appeals court affirmed, holding that under UETA each transaction must be examined to determine whether the parties agreed to conduct the transaction by electronic means. Here, the court held, there was no express or implied agreement between the parties that the bank would electronically sign the agreement. Further, the court held that even assuming the parties agreed to conduct the transaction electronically, the bank did not electronically sign the agreement. The court explained that “whether a sender has electronically signed an attached document depends on the circumstances, including whether the attached document itself contains the sender’s electronic signature and whether the attached document is intended to be a draft or final version.” In this case, the purported agreement the buyers sought to enforce was attached to an electronically signed email, but the signature lines in the attached agreement lacked the bank’s handwritten or electronic signature. The court added that the subject email and subsequent emails indicated that neither party considered the agreement to be final.
On May 23, the U.S. District Court for the District of Utah dismissed a putative class action filed against an ecommerce merchant for allegedly operating a financing program that violated various California laws, including the state’s usury law. Sawyer v. Bill Me Later, Inc., No. 11-988, 2014 WL 2159044 (D. Utah May 23, 2014). The court explained that the customer chose to finance his online purchase and was required to sign a contract: (i) identifying a Utah-chartered bank as the lender and as the owner of the account; (ii) specifying that the customer was accepting the loan in Utah, credit was being extended from Utah, and an annual interest rate of 19.99% would apply to outstanding loan amounts; and (iii) disclosing a schedule for late fees. The bank funded the transaction by paying the merchant on the customer’s behalf and held the receivables for at least two days before selling them to the merchant. The customer sued after he failed to pay for the purchase within 30 days and the merchant applied the disclosed interest rate and assessed a late fee, which the customer claimed together exceeded the usury cap in California, where the purchase was made. The court rejected the customer’s claim that the merchant, rather than the bank, was the “true lender” or the real party in interest. The court determined that “the lending framework more closely resembles credit card programs than the circular payday loan structures” described by the customer. The court concluded that loans serviced through contracts with third parties such as the merchant in this case are included within the definition of “any loan” under Section 27 of the Federal Deposit Insurance Act and as such are expressly preempted by federal statute.
On May 16, the Conference of State Bank Supervisors Emerging Payments Task Force held a public hearing to examine the changing payments landscape and opportunities and risks presented by current and emerging technologies. The Legacy Payment Systems panel focused on continued efforts to improve efficiency and speed while simultaneously “preserving consumer confidence and system stability.” The Retail Payments Innovations panelists described innovative electronic and mobile payment systems and suggested that further innovation would be best supported by existing regulatory framework, which offers sufficient consumer protections. Finally, the Virtual Currencies panel urged state and federal regulators to “provide clear and consistent regulatory expectations and guidance without restricting innovation.” The event was the most recent of a number held by federal and state policymakers to address the proliferation of emerging financial technologies used to move money and transfer funds, which range from enhancements of traditional ACH or credit and debit methods of payment to virtual currencies that disrupt the traditional model. The CSBS is expected to use public hearings like this one to develop a proposed regulatory framework for state agencies.
On May 19, the Senate Banking Committee’s chairman and ranking member, Senators Tim Johnson (D-SD) and Mike Crapo (R-ID), sent a letter to the leaders of the Treasury Department, the SEC, the CFTC, the OCC, the FDIC, and the Federal Reserve Board regarding recent developments in the use of virtual currencies and their interaction with the global payment system. The Senators ask the regulators a series of questions related to the role of virtual currencies in the U.S. banking system, payment system, and trading markets, and the current role of federal regulators in developing local, national, and international enforcement policies related to virtual currencies. The Senators also seek the agencies’ expectations on virtual currency firms’ BSA compliance, and ask whether an enhanced regulatory framework for virtual currencies is needed.
Nevada Federal District Court Stays Discovery Based On Lack Of Jurisdiction Over Foreign Website Operator
On May 15, the U.S. District Court for the District of Nevada granted a motion to stay discovery pending adjudication of the motion to dismiss on the grounds that it likely lacked personal and specific jurisdiction over the foreign operator of a passive website that conducted no act in Nevada other than the use of an allegedly infringing trademark, notwithstanding the website’s marketing claims of a significant U.S. presence. Best Odds Corp. v. iBus Media Ltd., No. 13-2008, slip op. (D. Nev. May 15, 2014). The court’s “peek” at the defendant’s pending motion to dismiss arguments led to the conclusion that it lacked personal jurisdiction over defendant despite plaintiff’s allegation, among others, that the defendant’s media kit stated that its website has a “significant U.S. presence” because that statement did not “approximate physical presence.” The court further concluded that it lacked specific jurisdiction, holding that the foreign operator’s site was passive and the operator did not purposefully direct its activities at the forum state or consummate a transaction within the forum state. The court rejected the plaintiff’s argument that the website was not passive because it allowed users to access third party travel websites to make reservations in the United States.
On May 12, the Connecticut Department of Banking issued a consumer advisory about risks associated with virtual currencies. The advisory provides background information and highlights benefits of virtual currency, but cautions that: (i) virtual currency is subject to minimal regulation and is susceptible to cyberattacks; (ii) virtual currency accounts are not backed by the FDIC; (iii) investments tied to virtual currency are volatile; (iv) investors in virtual currency reply upon “unregulated companies that may lack appropriate internal controls and may be more susceptible to fraud and theft than regulated financial institutions;” and (v) investors will have to rely upon the strength of their own computer security systems, as well as security systems provided by third parties to protect from cyberattacks.