By Jonathan D. Joseph
When the US Treasury’s Financial Crimes Enforcement Network, a/k/a FinCEN, published an interpretative ruling on March 18, 2013 discussing how its regulations applied to users, exchangers and administrators of virtual currencies, Mt. Gox, the world’s largest exchange for Bitcoin transactions, should have taken note. Mt. Gox and other early pioneers in the virtual currency space have anarchist roots and generally eschew governmental regulation; however, it is now clear that the survivors in the Bitcoin and cryptocurrency ecosystem will be those that successfully navigate the complex web of federal and state money transmission laws and regulations.
Earlier this week, Homeland Security Investigations (“HSI”) obtained a warrant, issued by the U.S. District Court of Maryland, authorizing U.S. government seizure of assets of Mt. Gox held at Iowa based payment processing start-up Dwolla and Wells Fargo Bank. HSI acted after it discovered that Mt. Gox, based in Tokyo, Japan, was operating as an unlicensed money transmission service through its American affiliate, Mutum Sigillum LLC, and it may have lied to Wells Fargo when it opened its initial US bank account.
FinCEN is the bureau of the Treasury Department that seeks to prevent money laundering and terrorism financing through its regulation of Money Service Businesses (“MSBs”). Its March 2013 guidance states that those dealing in or administering virtual currencies such as exchanges like Mt. Gox, but not users or “miners”, need to register as MSBs and comply with anti-money laundering regulations. While Bitcoin is the best-known cryptocurrency or digital currency, others have sprung up recently, including Opencoin, Litecoin, Terracoin, Feathercoin and Novacoin, among others. While concepts underlying virtual or cryptocurrencies can be mind- numbingly complex, the FinCEN guidance is reasonably clear as to who is regulated:
“A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.” FIN-2013-G001, March 18, 2013.
FinCEN categorizes participants in the virtual currency market into three generic categories: “user,” “exchanger,” and “administrator.” A user is a person that obtains virtual currency to purchase goods and services. An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds or other virtual currency. An administrator is a person engaged as a business in issuing (circulating) a virtual currency and who has the authority to redeem or withdraw from circulation that virtual currency.
A person may engage in “obtaining” a virtual currency in a number of different manners such as “earning,” “mining,” “harvesting,” “manufacturing,” “creating,” and “purchasing,” depending on the details of the specific virtual currency model involved. FinCEN concluded that how a person obtains a virtual currency is immaterial to the legal characterization under the Bank Secrecy Act of the process or of the person engaging in the process. This means that a user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not a Money Service Business under FinCEN’s regulations. Users must still be cautious, as an activity which is exempt from FinCEN’s rules, may still violate other federal or state statutes, rules and regulations. Additionally, almost all states have money transmission laws that may apply even if FinCEN rules do not.
An administrator or exchanger that (1) accepts and transmits a convertible currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations, unless a limitation or exemption from the definition applies to the person. As one illustration, a federally-insured commercial bank is exempt from the definition. However, in most cases, whether a person is a money transmitter is a matter of facts and circumstances. Under FinCEN’s interpretations and the law of many states there is no differentiation between real currencies and convertible virtual currencies. Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under BSA regulations. 31 CFR section 1010.100(ff)(5)(i)(A).
An exchange’s activities most often involve acting as a seller of Bitcoins or other virtual currency where it accepts real currency or its equivalent from a user/purchaser and transmits the value of the real currency to fund the purchaser’s virtual currency account held by an administrator. In the Dwolla/Mt. Gox case described above, users were transferring U.S. Dollars to Mt. Gox’s American affiliate via Dwolla. Prior to the HSI seizure, the American affiliate had been transferring U.S Dollars received from Dwolla to Mt. Gox in Japan and Mt. Gox allegedly used the Wells Fargo account to route funds from Japan to and from accounts at Dwolla at the direction of users. Dwolla, headquartered in Des Moines, offered an easier way for people to buy or sell Bitcoins through Mt. Gox, rather than attempting international wires to and from the company’s Japanese bank.
Under FinCEN regulations, sending “value that substitutes for currency” to another person or to another location constitutes money transmission, unless a limitation to or exemption from the definition applies. Consequently, based on the HSI warrant, Mt. Gox was transmitting funds to another location, namely from the user’s real currency account at a bank to the user’s virtual currency account with the administrator. The government alleges this is illegal since the only services being provided are unlicensed money transmission services.
Once a person or entity is engaging in the business of money transmission (both real or virtual currencies), doing so without registering with FinCEN as a Money Service Business and obtaining licenses under State money transmitter laws is mandatory unless certain enumerated exemptions apply. Most States including California, New York, Florida, Texas and Illinois and the District of Columbia require money transmitting businesses to obtain a license and comply with the other regulatory requirements (unless certain exemptions apply). Failure to be registered and licensed can constitute a felony.
The fervor of the cyrptocurrency movement is starting to resemble the California Gold Rush after gold was discovered in 1849. Millions of dollars are being invested in starts-up companies mainly in the Silicon Valley as Bitcoin entrepreneurs and venture capitalists race after what some believe could ultimately be worth billions. In fact, Opencoin recently announced it had completed an angel round which included Silicon Valley heavy hitters Andreessen Horowitz, Lightspeed Venture Partners and Barry Silbert’s Bitcoin Opportunity Fund.
Importantly, it doesn’t appear that Homeland Security or FinCEN is cracking down on Bitcoin itself, just on how it’s being exchanged by Mt. Gox. This is good news for Mt. Gox’s US-based competitors, such as Seattle-based CoinLab and San Francisco-based Coinbase, Bitcoin exchanges that have registered with the Treasury Department as money transmitters.
An important lesson for entrepreneurs and VCs entering the virtual currency space is that virtual currency business models must be analyzed by lawyers with corporate and venture capital expertise, as well as deep familiarity with state and federal currency and money transmission laws. For those that would turn a blind-eye to the necessity of robust legal compliance at an early stage based on libertarian or anarchist beliefs, naivety or an extraterritorial structure, failure is almost certainly guaranteed.
Smart entrepreneurs understand this. Success stories include PayPal, Square and presently Google Payment Corp., and Facebook Payments are muscling into the space. Staying lean until proof of concept has been achieved is important, but when it comes to federal and state money transmitter regulation, early angel and VC investment rounds must include funds for legal compliance. Joseph & Cohen has the expertise and experience to successfully establish and plan innovative legal compliance programs for VCs, virtual currency and Bitcoin start-ups.
Jonathan Joseph is the Managing Partner of Joseph & Cohen, Professional Corporation, a Financial Services and Litigation Boutique headquartered in San Francisco that emphasizes complex banking, corporate and venture capital transactions, regulatory and money transmission activities, securities, M & A, bankruptcy and insolvency, employment law and commercial and executive employment litigation services.
For additional information about Joseph & Cohen, Professional Corporation, please visit our website at www.josephandcohen.com or contact Jonathan Joseph at 415-817-9250 or firstname.lastname@example.org.
Bankruptcy Attorney David Honig Joins Boutique Financial Services and Litigation Law Firm – Joseph & Cohen
SAN FRANCISCO, CA – May 2, 2013. Joseph & Cohen, Professional Corporation, announced today that leading bankruptcy and restructuring attorney David A. Honig has joined the Firm as a Partner. Mr. Honig, who has worked in the restructuring field for over 20 years, comes to Joseph & Cohen after his successful 10-year tenure as a corporate partner at Winston & Strawn LLP, a prestigious international law firm, where he practiced in that firm’s restructuring and insolvency group in San Francisco. Prior to that, he was a partner at San Francisco-based Murphy Sheneman Julian & Rogers (previously known as Murphy Weir & Butler), a nationally recognized bankruptcy and restructuring boutique, which he joined as an associate in 1992.
Mr. Honig’s arrival at Joseph & Cohen significantly broadens the boutique firm’s core banking, financial services, regulatory, and litigation expertise. He is a talented and multifaceted financial services lawyer who was recently selected by his peers for inclusion in The Best Lawyers in America® 2013 in the field of Litigation – Bankruptcy.
During his career he has specialized in business restructuring, insolvency, corporate finance, and related transactions and litigation. He is known for his ability to create practical, business-oriented solutions to complex legal and financial problems.
Mr. Honig represents debtors, institutional and non-traditional lenders, trustees, receivers, official creditors’ committees, private equity funds, vendors, licensors, real and personal property lessors, and asset purchasers in bankruptcy, receivership, and other restructuring and workout matters in and out of court. He has extensive experience in the reorganization of distressed financial services businesses, vineyards and wineries, and other food and beverage companies, as well as manufacturing, technology, telecommunications, retail, and real estate investment concerns.
“We are both flattered and honored that David Honig chose Joseph & Cohen over the countless opportunities available to him,” said Jonathan Cohen, litigation partner at Joseph & Cohen. “His bankruptcy, workout and litigation expertise will undoubtedly further our standing as a well-rounded and world-class boutique firm.”
Of his new position, Mr. Honig stated, “Joseph & Cohen impressed me with their vision, energy, and depth of experience. I look forward to working with them. Together, we’ll provide exceptional service to our clients throughout California and the United States.”
Joseph & Cohen, Professional Corporation, is a Financial Services and Litigation Boutique headquartered in San Francisco that emphasizes complex banking, corporate and transactional matters, regulatory and bank enforcement defense, securities, M & A, bankruptcy and insolvency, employment and commercial and executive employment litigation services. Joseph & Cohen is known for sophisticated expertise, extraordinary commitment to clients, relationship-based services, and a range of specialized skills typically found only in the largest American law firms.
Press Contact: Jonathan Joseph at Joseph & Cohen, 415-817-9200, ext. 9 or email@example.com.
SAN FRANCISCO, CA – March 22, 2013. Joseph & Cohen, headquartered in San Francisco, rolled out a new marketing campaign today as part of its sponsorship of the Western Independent Bankers’ (WIB) Annual Conference for Bank Presidents, Senior Officers & Directors being held in Kauai, HI from March 23 – 27, 2013. Managing Partner Jonathan Joseph notes, “Joseph & Cohen is proud to be a major sponsor of WIB for the fourth consecutive year. WIB’s commitment to assist bankers and directors in navigating the complex changes in the industry mirrors our own.”
For this year’s marketing sponsorship, Joseph & Cohen, which specializes in representing independent and regional banks, chose the image below of a well-dressed attorney riding a skateboard. The concept emphasizes the firm’s ability to solve complex legal matters with skill and agility in a laid-back but professional and cutting edge manner. Joseph & Cohen believes its fresh vision provides a competitive edge in connecting with the next generation of banking leaders.
To learn more, call 415.817.9200 to speak to either of the firm’s name partners: Jonathan Joseph or Jon Cohen.
SAN FRANCISCO, CA – November 13, 2012. Joseph & Cohen, Professional Corporation, located in San Francisco, California, announced today that it successfully structured a settlement for its clients, five former officers of County Bank, Merced, California, in connection with a lawsuit brought by the Federal Deposit Insurance Corporation, in its capacity as receiver for County Bank. County Bank, which collapsed in February 2009, had been the wholly-owned banking subsidiary of Capital Corp of the West (Nasdaq: CCOW).
The case, which was filed by the FDIC in the Federal Court in Fresno, California in January 2012, was titled FDIC, as receiver for County Bank v. Hawker, et al., (Case No. 1:12-CV-000127-LJO) (“FDIC v. Hawker”). The settlement completely settles and satisfies all claims brought by the FDIC against the five former officers of the Bank: Thomas Hawker, Edward Rocha, John Incandela, David Kraechan and Jay Lee (the “officers”).
A companion case that the officers filed against BancInsure, Inc. and the FDIC in July 2012, in the same Fresno based Court, remains outstanding. In that case, Hawker et al v. BancInsure (Case No. 1:12-cv-01261-LJO-GSA), Tom Hawker and the other officers asserted claims against BancInsure for declaratory relief, breach of contract, bad faith, punitive damages and reformation. The officers were forced to sue BancInsure, the professional liability insurer for County Bank, after it abandoned them and refused to defend the claims in the FDIC Action.
Jonathan Joseph, counsel for the officers stated “We believed that we had strong legal and factual defenses to the FDIC’s claims. In our view, County Bank collapsed as a result of the greatest recession in our lifetime. So, we vigorously defended Tom Hawker and the other four officers of County Bank against all of the government’s allegations. But, after the D&O Insurer abandoned our clients and refused to defend them or settle the FDIC lawsuit, we are pleased to have successfully structured this deal with the FDIC as the settlement eliminates all claims, further uncertainty and the trouble, risk and expense associated with the litigation.”
An essential element of the settlement involved an assignment to the FDIC by the officers of their lawsuit against BancInsure including claims for bad faith and breach of contract. The officers retained the right to recover their defense expenses incurred prior to the FDIC settlement from BancInsure. The officers maintained the right to continue to control and prosecute this retained claim against BancInsure.
Tom Hawker, former CEO of County Bank and President and CEO of CCOW, said “I am relieved to put this case behind me as it eliminates further uncertainty, cost or risk to me and my family. I am outraged that the Bank’s D&O insurer abandoned me as I would have been financially ruined if I continued to defend myself against the FDIC’s allegations despite having excellent legal and factual defenses to their claims.”
As a result of the settlement, the FDIC will control and prosecute the officers’ assigned claims against BancInsure at its cost and expense. Jon Cohen, litigation partner at Joseph & Cohen, explained “We look forward to litigating alongside the FDIC on behalf of our clients to prove that BancInsure improperly applied the so-called “insured versus insured” exclusion to deny the coverage our clients had expected and relied upon.”
The parties exchanged other valuable covenants including an agreement not to bring any other civil claims against each other and a promise by the FDIC not to take any further action or assert any claims against any of the property or assets of the officers.
Joseph & Cohen, Professional Corporation, is an AV® rated law firm based in San Francisco, California, that emphasizes the representation of community and regional banks and bank holding companies and their officers and directors. The firm also specializes in representing financial service companies, credit unions and private equity firms in connection with corporate, securities, regulatory, litigation, executive employment and merger matters. Joseph & Cohen is known for sophisticated expertise, extraordinary commitment to clients, relationship-based services, and a range of specialized capabilities typically found only in the largest American law firms.
By Jonathan Joseph*
The total number of bank failures since the banking crisis began in 2008 is now dangerously close to 400. To date, the FDIC has only filed 14 lawsuits against failed bank directors and officers from thirteen different failed banks. A total of 103 former bank directors and officers have been named in these suits.
Based on published statistics and our own analysis of U.S. bank failures from 2008 to September 16, 2011, we believe that approximately 80 additional suits will be brought by the FDIC, as receiver, in the next two years. While the FDIC’s investigation and claim process has moved slowly, the number of damage suits authorized and filed is quickening and, we expect, will spike in 2012.
In August 2011, 5 new suits were filed, more than double any previous month. Currently, the FDIC’s website states it has authorized suits in connection with 32 failed institutions against 294 individuals for D&O liability with damage claims of at least $7.2 billion. All but one of these suits involved banks that failed prior to July 2009. Consequently, while 14 lawsuits have been filed and the FDIC has approved claims against an additional 191 directors and officers who served 18 different failed banks, this significantly understates the number of new suits to be filed and D&O’s to be named.
The current round of bank failures began somewhat slowly in 2008. The closing of IndyMac Bank in July 2008 marked the beginning of a huge acceleration of failures with 140 failures in 2009 and 157 in 2010. The pace has slowed in 2011 with 71 failures year to date. Some of the 18 authorized FDIC lawsuits not yet filed may settle; however, the FDIC will approve additional lawsuits against bank directors and officers at an increased pace in the ensuing months because 252 or 64 percent of the current round of bank failures occurred between July 9, 2009 and December 31, 2010. The FDIC is now approaching the decision point in many of these pre-2011 failures including the retention of outside law firms to prosecute damage claims on its behalf, as receiver.
D&O liability suits are generally only pursued if the FDIC concludes they are both meritorious and cost-effective. Before seeking recoveries from individual directors and officers, the FDIC conducts an investigation into the causes of the failure. The FDIC states on its website that investigations are usually completed within 18 months from the time the institution is closed, but lawsuits typically aren’t filed for another few months to a year. Investigations can extend longer and lawsuits are sometimes filed just before the third anniversary of a bank’s failure.
Here are some illustrations: Georgia’s Silverton Bank failed on May 1, 2009 and suit was filed on August 22, 2011 (27 months). Haven Trust Bank in Georgia failed on December 12, 2008 and suit wasn’t filed until July 14, 2011 (32 months). Cooperative Bank in North Carolina was closed in June 2009 and suit was filed August 10, 2011 (26 months). On the other hand, Wheatland Bank in Illinois failed on April 23, 2010 and suit was filed on May 5, 2011 (13 months). With $11.2 billion in assets, San Francisco based United Commercial Bank was closed and most of its assets were assumed by East West Bank on November 6, 2009. Yet after almost two years, no public announcement of FDIC damage claims against any of UCB’s executive officers and directors have surfaced. United Commercial Bank was California’s largest ever commercial bank failure.
Not all bank failures result in Director and Officer (D&O) lawsuits. The FDIC brought claims against directors and officers in 24 percent of the bank failures between 1985 and 1992. Since July 2009, the FDIC was named receiver at 323 failed banks. Bank failures have been most heavily focused in Georgia (70), Florida (56), Illinois (45), California (37), Washington (17) and Minnesota (16). If one assumes the same 24 percent ratio of suits from the 1985 – 1992 era will be repeated in connection with failures since June 2009, former directors and officers of about 80 additional banks could be targets of FDIC damage suits in the next two years in addition to the 14 suits already underway. The actual number could be somewhat higher but we doubt it will be much lower.
Prior to filing a lawsuit against a director or officer of a failed bank, staff for the FDIC, in its capacity as the receiver (or outside counsel representing the FDIC as receiver), will mail a demand letter to the bank’s officers and directors asserting the FDIC’s claims for monetary damages arising out of the bank’s failure. These demand letters typically do not distinguish between the different roles that officers and directors may have played under the circumstances nor is much effort made (at this point in the process) to determine which officers and directors in a particular organization may have been negligent, grossly negligent, breached fiduciary duties or wasted assets.
In a number of recent suits, the FDIC has focused on outside directors that had more banking industry expertise than other directors (i.e., directors of Silverton Bank) who were not themselves professional bankers. Directors with lending, accounting and CPA expertise may potentially be held by FDIC to higher standards, which could make them more visible targets. Often the FDIC’s demand letter is sent to trigger a claim under the bank’s director and officer liability policy and as part of an attempt to settle with the responsible parties. If a settlement cannot be reached, however, a complaint will be filed, typically in federal court. Thus, in many of the upcoming lawsuits, the FDIC may pursue claims against individuals but will also focus on the insurance proceeds that could be available in connection with many failures especially those that occurred prior to 2011 (when regulatory exclusions were not as widespread).
It is crucial that officers and directors of a troubled or failed bank retain knowledgeable insurance coverage and bank regulatory counsel to assert rights to coverage under the bank’s liability policies and to determine whether the facts and circumstances raise unique or special legal defenses. Officers and directors of all distressed banks should attempt to retain experienced outside counsel prior to a bank’s failure as the bank’s existing counsel will usually be conflicted out upon failure. Notice of circumstances that could give rise to coverage under a policy should be filed with insurers on a timely basis (usually pre-failure) and written follow-up by coverage counsel with insurers post-failure is often be necessary. If a director or bank officer hasn’t done so prior to failure, they should always retain experienced counsel at the first hint of an investigation or demand arising out of the bank failure.
In many of cases, the FDIC’s ultimate objective will be the recovery of D&O insurance proceeds. For this reason, it is often advisable to retain a combined legal team that has the capability to address insurance issues, liability and damage claims, regulatory enforcement actions (such as banking industry bans and civil money penalties) and, in rarer cases, criminal probes and indictments.
*About the Author: For over thirty-two years, Jonathan Joseph has focused on the representation of community and regional banks and officers and directors of distressed and failed banking organizations in connection with regulatory, transactional and corporate matters. He is a member of the Financial Institutions Committee of the California State Bar and a leading banking industry lawyer in California. Mr. Joseph founded the firm of Joseph & Cohen, Professional Corporation, in 2006 and is its Chief Executive Officer. Joseph & Cohen currently represents financial institutions and officers and directors of troubled and failed banks from its office in San Francisco, CA.
For additional information, please email the author: Jon@JosephandCohen.com.
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