Virtual Currency Regulation and Enforcement: Granting of First NY Charter and FinCEN Fine Demonstrate Continued Evolution for Virtual Currency Sector

May 27, 2015

The last several months have demonstrated the continued growth, volatility and regulation of the virtual currency industry.  A number of Wall Street institutions and established technology companies have made sizeable investments in virtual currencies and the underlying blockchain technology, and investors aren’t the only ones who continue to be interested in the development of virtual currencies.  Regulators at the federal and state level have recently taken important actions that will continue to shape the nascent regulatory environment.  In particular, we discuss below two recent developments:  (1) New York’s issuance of the first charter to a virtual currency company and (2) a recent FinCEN enforcement action against the second-largest U.S. virtual currency company. 

New York Department of Financial Services Grants First Charter to Virtual Currency Company

On May 7, 2015, DFS granted its first charter[1] under New York Banking Law to a virtual currency company–itBit Trust Company, LLC (itBit), a commercial Bitcoin exchange that will allow customers to buy, sell, and hold digital currency as an asset.[2]  The limited purpose trust company charter awarded to itBit allows the company to commence its virtual currency operations immediately, sidestepping the soon-to-be-announced final BitLicense framework.[3]  itBit was granted a license after applying for a charter only three months earlier in February 2015, though it is reported that itBit began the charter process and negotiations sometime in early 2014.[4] 

Similar to the proposed BitLicense requirements, itBit was subject to a "rigorous review" that included, among other things, a review of the company’s anti-money laundering, capitalization, consumer protection and cybersecurity standards.[5]   In addition, itBit will continue to be subject to supervision by the DFS as both a trust company and, when finalized later this month, a company subject to BitLicense regulations.[6]

itBit is the currently the only company licensed to conduct a virtual currency business in New York.  Time will tell how long that will remain the case, as well as the significance of that fact as virtual currency companies compete for a greater share of the U.S. market.[7] 

FinCEN Assesses a $700,000 Penalty for BSA/AML Violations

On May 5, 2015, Ripple Labs Inc. (Ripple) and XRP II, LLC (XRP and, collectively, the Companies) entered into a Consent to the Assessment of Civil Money Penalty (the Consent) with the Financial Crimes Enforcement Network (FinCEN) for violations of the Bank Secrecy Act (BSA) related to the Companies’ engagement in the sales of approximately $1.3 million in virtual currency.[8]  On the same day, the Companies also entered into a Settlement Agreement with the U.S. Attorney’s Office for the Northern District of California, avoiding criminal charges related to their activities described above.[9]

FinCEN assessed a civil money penalty against Ripple, the second-largest U.S. digital currency company in terms of market capitalization, for willfully violating the BSA when it first started selling virtual currency on March 6, 2013 without registering as a money services business.  Ripple continued to operate without registering, despite March 18, 2013 FinCEN guidance that specifically addressed registration requirements for virtual currency transmitters.[10]  Additionally, Ripple was also cited for its failure to establish an anti-money laundering (AML) program throughout the two months it engaged in the sales of virtual currency.[11]

XRP, a FinCEN registered money service business and subsidiary of Ripple, assumed Ripple’s functions of selling virtual currency in April 2013.  Despite registering with FinCEN, XRP was cited for its failure to implement and maintain an adequate AML program; XRP initially operated without any AML procedures or policies for several months, operated without a compliance officer for three months, and did not conduct its first risk assessment until six months after assuming the business from Ripple.  XRP was further cited for its failure to report suspicious activities related to several questionable transactions.[12]

The Companies were assessed a penalty of $700,000 and required to perform several remedial undertakings,[13] pursuant to 31 U.S.C. § 5321 and 31 C.F.R. § 1010.820.  In connection with the Settlement Agreement, which resolved a criminal investigation, the Companies were also subject to a forfeiture of $450,000, which would be credited against FinCEN’s assessment upon payment.[14]  Remedial undertakings require the Companies’ to establish adequate AML/BSA compliant policies and programs, as well as transfer all virtual currency business to registered money service businesses.  The virtual currency community took particular issue with a remedial measure to make "enhancements to the Ripple protocol."[15]  These required enhancements were cited as a concern that they could allow FinCEN to alter companies’ protocols and monitor counterparties that use the underlying software program that runs Ripple’s network.[16]  

Conclusion

These two developments demonstrate that despite continued volatility and challenges, virtual currency businesses are increasingly viewed as more mainstream–and therefore are attracting heightened attention from regulators.  As start-ups and established companies continue to innovate–leading to greater investments in bitcoin consumer services and exchange providers, accelerator programs, active exploring of ways to leverage blockchain technology, and a crossover of executives into the virtual currency sector–we anticipate there will continue to be  growth, additional state initiatives to attract virtual currency start-ups, and increased regulatory scrutiny at both the state and federal levels.  One of the most significant forthcoming developments that we will monitor is the release of the much-anticipated final DFS BitLicense regulatory framework, which is expected in the coming days.   


   [1]   See Authorization Certificate for ItBit Trust Company LLC (May 6, 2015), available at http://www.dfs.ny.gov/banking/auth_cert_itBit_052015.pdf; see also Reem Nasr, NY Grants First Banking License to Bitcoin Exchange itBit, CNBC, May 7, 2015, http://www.cnbc.com/id/102658751.

   [2]   Press Release, N.Y. State DFS, DFS Grants First Charter To A New York Virtual Currency Company (May 7, 2015), http://www.dfs.ny.gov/about/press2015/pr1505071.htm.

   [3]   As we discussed in a previous alert, the DFS outlined an updated BitLicense regulatory framework in December 2014 and a finalized version is expected at the end of this month.  See Developments in Virtual Currency: Regulation and Enforcement Actions Gain Momentum (Jan. 5, 2015), http://www.gibsondunn.com/publications/pages/Developments-in-Virtual-Currency–Regulation–Enforcement-Actions-Gain-Momentum.aspx.

   [4]   Nathaniel Popper, Bitcoin Exchange Receives First License in New York State, N.Y. Times Dealbook (May 7, 2015), http://www.nytimes.com/2015/05/08/business/dealbook/bitcoin-exchange-receives-first-license-in-new-york-state.html?_r=0.

   [5]   Press Release, N.Y. State DFS, DFS Grants First Charter To A New York Virtual Currency Company (May 7, 2015), http://www.dfs.ny.gov/about/press2015/pr1505071.htm.

   [6]   Id.

   [7]   For example, Coinbase, a virtual currency company based in San Francisco, is attempting to open the first exchange with all necessary licenses in the United States, but has yet to obtain regulatory approval in New York.  See Pete Rizzo, DFS: Coinbase Is Not Licensed in New York, Coindesk (Jan. 28, 2015, 17:23 BST), http://www.coindesk.com/nydfs-coinbase-licensed-new-york/.

   [8]   United States Dep’t of the Treasury, Financial Crimes Enforcement Network, Assessment of Civil Money Penalty, In re Ripple Labs Inc. and XRP II, LLC, No. 2015-05 (May 5, 2015), available at http://www.fincen.gov/news_room/nr/pdf/Ripple_Assessment.pdf.

   [9]   Settlement Agreement, United States Dep’t of Justice (May 5, 2015), http://www.justice.gov/sites/default/files/opa/press-releases/attachments/2015/05/05/settlement_agreement.pdf.

  [10]   News Release, United States Dep’t of the Treasury, Financial Crimes Enforcement Network, FinCEN Issues Guidance on Virtual Currencies and Regulatory Responsibilities (Mar. 18, 2015), http://www.fincen.gov/news_room/nr/html/20130318.html.  See Gibson Dunn Client Alert, U.S. Developments in Virtual Currencies: FinCEN Administrative Rulings and New York Department of Financial Services Hearings (Feb. 12, 2014), http://www.gibsondunn.com/publications/pages/US-Developments-in-Virtual-Currencies–FinCEN-Administrative-Rulings-and-New-York-Department-of-Financial-Services-Hearings.aspx.

  [11]   See United States Dep’t of the Treasury, Financial Crimes Enforcement Network, Assessment of Civil Money Penalty, In re Ripple Labs Inc. and XRP II, LLC, Attachment A: Statement of Facts and Violations (May 5, 2015), available at http://www.fincen.gov/news_room/nr/pdf/Ripple_Facts.pdf.

  [12]   For example, XRP processed a $250,000 transaction despite a customer’s refusal to complete a "know your customer" form.  In another instance, XRP declined to process a $32,000 payment because it "doubted the legitimacy of the overseas customer’s source of funds," but failed to report its suspicions.  Id.

  [13]   See United States Dep’t of the Treasury, Financial Crimes Enforcement Network, Assessment of Civil Money Penalty In re Ripple Labs Inc. and XRP II, LLC, No. 2015-05, Attachment B: Remedial Framework (May 5, 2015), available at http://www.fincen.gov/news_room/nr/pdf/Ripple_Remedial_Measures.pdf.

  [14]   Assessment of Civil Money Penalty, In re Ripple Labs Inc. and XRP II, LLC, Attachment A: Statement of Facts and Violations, supra note 11.

  [15]   Assessment of Civil Money Penalty In re Ripple Labs Inc. and XRP II, LLC, No. 2015-05, Attachment B: Remedial Framework, supra note 13.

  [16]   Michael J. Casey, BitBeat: Day After FinCEN Bombshell, Ripple Labs Addresses Concerns, WALL ST. J. MONEYBEAT BLOG (May 6, 2015, 11:31 PM ET), http://blogs.wsj.com/moneybeat/2015/05/06/bitbeat-day-after-fincen-bombshell-ripple-labs-addresses-concerns/ 

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