Alert November 06, 2014

FinCEN Continues Scrutiny of Virtual Currency Companies

Summary

The Financial Crimes Enforcement Network recently issued two administrative rulings holding that certain virtual currency trading platforms and payment systems were subject to registration as money services businesses.

On October 27, 2014, the Financial Crimes Enforcement Network (FinCEN) issued two administrative rulings holding that certain virtual currency trading platforms and payment systems are money transmitters and subject to registration and other requirements applicable to money services businesses (MSBs).

Guidance Concerning Trading Platforms

In the first administrative ruling FinCEN ruled that a company setting up an exchange trading platform was an MSB and a money transmitter. The company proposed to set up a trading system to match offers to buy and sell convertible virtual currency for real currency and a set of book accounts in which prospective buyers or sellers of one type of currency or the other could deposit funds to pre-fund their exchanges. The accounts in which customer funds were to be held were to be maintained separately from the operating accounts of the company and protected from the company’s creditors. The company planned to act as an intermediary between buyers and sellers, without identification of the parties to the transactions to each other.

The company was already registered as a money transmitter and a dealer in foreign exchange with FinCEN, but argued that it should not have to continue its registration as a money transmitter because (i) the trading platform operated in a similar manner to securities or commodities exchanges; (ii) the company was not transmitting money to counterparties; (iii) any money transmission activities of the company were integral to its business or exempt as payment processor activities; and (iv) the company was a “user” of convertible virtual currency and therefore exempt from registration under earlier FinCEN rulings.

FinCEN rejected each of the company’s arguments, saying that it was engaged in money transmission because it was accepting and transmitting currency, funds or other value that substitutes for currency. The agency did not accept the company’s arguments that the conditional nature and anonymity of the exchanges affected whether the activities were money transmission. It also rejected the company’s position that its activities were similar to traditional broker/dealer activities or eligible for any of the exemptions in the MSB rules.

Guidance Concerning Payment Systems

The second administrative ruling found that a company taking payments in real currency from customers of merchants participating in its payments system, exchanging those funds for bitcoin and transmitting the bitcoin to the merchants must register with FinCEN as a money transmitter. This particular business was designed in part to reduce the effects of currency fluctuation in certain Latin American countries by transmitting bitcoin to hotels in payment for reservations made by guests using payment cards. The bitcoin payments made by the company to merchants were going to be funded from the inventory of bitcoin maintained by the company.

FinCEN ruled that the company was an “exchanger” because it is engaged as a business in accepting and converting real currency from customers of the merchants into virtual currency for transmission to the merchant. FinCEN further ruled that the company did not qualify for exemption as a payment processor because it failed to meet one of the conditions of the exemption: that the system was not operating through clearance and settlement systems that admit only Bank Secrecy Act-regulated financial institutions. It also stated that the money transmission engaged in by the company was not integral to provision of other services and therefore was not exempt.

Continuing Regulatory Scrutiny

These most recent rulings reflect both the continued interest of virtual currency platforms in gaining clarity about the regulatory landscape and FinCEN’s interest in ensuring that companies that operate money services businesses are appropriately regulated. Of additional interest is what the effect, if any, of these rulings will be on state efforts to regulate virtual currencies.

If you would like additional information about the issues addressed in this Client Alert, please contact Grant Fondo, a partner in Goodwin Procter’s Securities Litigation & White Collar Defense Group and its Privacy & Cybersecurity Practice, Lynne Barr, a partner in the firm’s Financial Institutions Group and co-chair of its Privacy & Cybersecurity Practice, or the Goodwin Procter attorney with whom you typically consult.