The use of digital currency and its underlying technology may be gaining traction in the traditional economy, but the industry remains a focus of law enforcement interest. The IRS, recognizing the opportunity for digital currency to be used as a possible vehicle for tax evasion, declared in March 2014 that digital currency is to be taxed as “property,” rather than as “currency.” Given the close relationship between the IRS and enforcement of the Bank Secrecy Act (BSA), the legal fields of tax controversy and tax compliance are necessarily affected by the evolving enforcement regime regarding the use – or misuse – of digital currency.
In United States v. Budovsky, No. 1:13-cr-00368 (DLC) (S.D.N.Y Sept. 23, 2013), the Southern District of New York recently declined to dismiss the indictment pending against Arthur Budovsky, the alleged former head of Liberty Reserve, a digital currency business that Budovsky and others allegedly created in 2006 and operated from Costa Rica after emigrating from the United States. As the district court explained, the indictment alleges in part that Liberty Reserve
. . . . emerged as the “financial hub of the cyber-crime world, facilitating a broad range of online criminal activity, including credit card fraud, identity theft, investment fraud, computer hacking, child pornography, and narcotics trafficking.” Liberty Reserve’s user base was global, with more than one million users worldwide, including more than 200,000 users in the United States. The Indictment further alleges that from 2006 to 2013, Liberty Reserve processed an estimated $5 million separate financial transactions and laundered more than $6 billion in criminal proceeds. At no point did Liberty Reserve register with the United States Department of the Treasury as a money transmitting business.
Id. at 3. The indictment charges Budovsky with three counts of conspiring to commit money laundering, in violation of 18 U.S.C. § 1956(h); one count of conspiring to operate an unlicensed money transmission business, in violation of 18 U.S.C. § 371; and one count of operating an unlicensed money transmission business, in violation of 18 U.S.C. § 1960. The defendant moved to dismiss all charges on several grounds. As described below, he failed; motions to dismiss indictments very rarely succeed, and the allegations contained within an indictment are presumed to be true for the purposes of a motion to dismiss. The Budovsky opinion discusses complex issues in detail; it is worthwhile reading, especially for anyone interested in digital currency, the regulation of money transmitting services under the BSA, and money laundering. This blog entry will discuss some of the specific issues analyzed by the Budovsky court: the extraterritorial application of the criminal statutes at issue and the application of the BSA to digital currency.
Extraterritorial Application of U.S. Criminal Statutes
The district court first addressed an issue of growing importance in criminal law: Congress’ ability (a function of the Due Process Clause) and intent (a function of statutory interpretation) to invest a criminal statute with extraterritorial effect. This issue historically tended to arise in narcotics and money laundering cases, but it now has spread to all sorts of cases, including criminal tax and Foreign Corrupt Practices Act cases. Defendant Budovsky argued that the entire indictment should be dismissed because the alleged conduct had no nexus with the United States. The district court, however, rejected that argument, finding that, even assuming that an indictment must describe the nexus between the offense and the United States, the indictment at issue alleged that “Liberty Reserve had over 200,000 users in the United States; the site’s users included criminal rings operating in the United States; Budovsky moved $13.5 million from a Costa Rican bank account held by Liberty Reserve through a correspondent bank account in the Southern District of New York; and Budovsky engaged in money laundering with the object of transferring funds in and out of the United States.” Id. at 12. The allegation regarding Liberty Reserve’s use of a U.S. correspondent bank account mirrors a similar jurisdictional allegation contained within the 2012 indictment against Wegelin & Co. (Wegelin), formerly Switzerland’s oldest bank. Wegelin, which had no physical U.S. presence but which used a U.S. correspondent bank account to transfer funds to its U.S. clients and which communicated with those clients via e-mail and fax, later pleaded guilty to tax fraud conspiracy based on the bank’s alleged assistance to U.S. clients seeking to hide assets and evade taxes.
Finally, the district court quoted language from the defendant’s brief that presumably was intended to suggest that the government’s position would produce unacceptable or absurd outcomes, but which instead may turn out to be – at least partly – prophetic: even if a large user base for Liberty Reserve in the U.S. created a sufficient nexus for extraterritorial application of the statutes, the defendant argued that “any operator of any web business – located anywhere in the world – could be hauled into United States Courts.” The district court rejected that claim as “theoretical,” and stated that the indictment at hand “sufficiently alleged the conduct of a criminal business with the aim of causing harm to U.S. citizens and U.S. interests.” Id. at 13.
Application of the BSA to Digital Currency
Defendant Budovksy further argued that the substantive Section 1960 charge against him failed to allege with sufficient specificity how he violated the BSA’s underlying money transmitting business registration requirements. During the course of a complicated discussion of the relevant statutes and regulations, the district court observed that BSA regulations defined a “money transmitting business” in part as “any other person who engages as a business in the transmission of funds, including . . . any network of people who engage in as a business in facilitating the transfer of money domestically or internationally outside of the conventional financial institutions system[.]” Further, the district court observed that the BSA regulations were amended in 2011 to define a “money services business,” which includes money transmitters, to include any “person wherever located doing business . . . wholly or in substantial part within the United States.” Id. at 19 (quoting 31 C.F.R. § 1010.100(ff)). The district court ultimately rejected the defendant’s claim, finding that that the indictment in fact identified the BSA regulations which require foreign fund transfer businesses to register with the Financial Crimes Enforcement Network, or FinCEN. Although this fact presumably provided the district court with the most expedient response to the motion to dismiss, it is not clear that such detailing of underlying regulations in a criminal count is even necessary. For example, in the criminal tax context, counts alleging tax evasion or the filing of false returns, in violation of 26 U.S.C. § 7201 and § 7206, respectively, almost never refer to the underlying tax statue or regulation which establishes that the allegedly concealed receipts are “income” that had to be reported during the given tax year. Generally, the law does not require such specificity in indictments.
The defendant also invoked the rule of lenity to argue that it was not clear that Liberty Reserve had to register as a money transmitter with FinCEN until FinCEN released interpretive guidance on March 13, 2013, which stated that the definition of a money transmitter under the BSA “does not differentiate between real currencies and convertible virtual currencies.” This guidance was discussed in detail by me and my colleague Mehreen Zaman, along with related issues of potential reporting duties under the BSA and the tax code for digital currency holdings as foreign financial accounts, in this article. The court rejected the defendant’s claim of legal ambiguity, describing the rule of lenity as a “rule of statutory construction of last resort,” and finding that the applicable statutes and regulations had defined “money transmitter” in such a way that Liberty Reserve represented a money transmitter at the moment of its inception in 2006.
The lesson here is relatively simple. If one operates a digital currency business that has a “substantial” business relationship with the United States, then – among other possible duties – one must register as a money transmitter with FinCEN (as well as with certain States, as required). This is true even if the business is dedicated to facilitating transactions that involve entirely legal enterprises. Of course, the U.S. government – and many U.S. courts – will apply a low threshold for the test for “substantiality.” Although operating abroad may create practical protections, it does not create legal ones. Regardless, the business reasons for any financial enterprise to operate effectively within the United States clearly indicate that long-term financial success turns in part on compliance with the BSA.