On Friday, September 16, 2022, the Department of Justice ("DOJ") announced a formalized focus on digital asset abuse by publically releasing a 46 page report on the Role of Law Enforcement in Detecting, Investigating, and Prosecuting Criminal Activity Related to Digital Assets (the "Report"). DOJ describes this Report as a "companion" to its other recent report, How to Strengthen International Law Enforcement Cooperation For Detecting, Investigating And Prosecuting Criminal Activity Related To Digital Assets, which was made public on June 6, 2022. As the name of the June 6, 2022 report suggests, the priority of this prior report was on cross-border enforcement collaboration as DOJ had noted that "uneven and often inadequate regulation and supervision, coupled with a lack of compliance enforcement for digital asset trading platforms and other service providers, allow criminals to expose the U.S. and international financial systems to risk . . . [through] 'jurisdictional arbitrage,'" i.e., "tak[ing] advantage of regulatory inconsistencies across jurisdictions, or in some cases, [a] complete lack of regulation and supervision." The more recent Report focuses on U.S. law enforcement and regulatory agencies.
The recent Report begins by providing a synopsis of how digital assets and platforms are vulnerable to exploitation by criminal actors. The Report emphasized the recent growth in Decentralized Finance ("DeFi") platforms, particularly in the last two years. The term DeFi platforms broadly refers to digital asset protocols and platforms that allow for some form of automated peer-to-peer transactions. These platforms often allow for the exchange of digital assets without any centralized person or entity, rather relying on distributed governance and the collective decision-making by the users of these platforms. In the Report, DOJ addresses several issues/vulnerabilities associated with DeFi platforms. First, these platforms are more transparent as their primary feature is that they are based on smart contracts and open-source code; however, this transparency both allows for malicious actors to exploit vulnerabilities in the system as well as makes it difficult to prosecute these actors under the current criminal statutes because the code itself allows for the exploitation to take place. Second, DOJ has also found that there is a challenge to regulatory enforcement of these platforms because there is no controlling entity or person who operates these platforms. Finally, DOJ has found that these DeFi platforms "create substantial money laundering risk" because they are "accessible to users worldwide for pseudonymous, one-off transactions, and [they provide the] ability to execute large, immediate, and automated financial transactions."
Among a number of actions DOJ presents as a step forward in the fight against the use of digital assets in criminal schemes, a critical component of DOJ's strategy is the establishment of the nationwide Digital Asset Coordinator ("DAC") Network. DOJ announced that 150 Federal Prosecutors from offices around the United States will comprise the newly formed DAC network. The National Cryptocurrency Enforcement Team ("NCET"), a dedicated team within DOJ assigned to focus on cyber and cryptocurrency issues, which was formed earlier in February of this year, will lead the network.1
The concurrently released Report explains that each district will have a dedicated Digital Asset Coordinator who will serve as the digital asset "subject matter expert" for their district, signaling that DOJ expects digital asset enforcement to take place nationally and is positioning itself to pursue digital financial crimes outside of traditional financial centers such as the Southern District of New York. The network will serve as a forum for training, expertise and guidance for the prosecution of digital asset crimes and will work in close coordination with the Criminal Division's Computer Crime and Intellectual Property Section and the Money Laundering and Asset Recovery Section's Digital Currency Initiative.
The Report explains that the new DAC Network was modeled after the Computer Hacking and Intellectual Property ("CHIP") Network established in 1995 and the National Security Cyber Specialist ("NSCS") Network launched in 2012. The creation of this network after the pattern of other networks formed by DOJ in response to technological developments (and the crimes that follow) marks a recognition of the "ever-evolving" challenges posed by the fast-paced industry of digital assets.
Notably the new DAC network and the DOJ appear to follow Executive Order 14067 in taking a more expansive definition of digital assets in contrast to other new initiatives from DOJ, such as the National Cryptocurrency Enforcing Team, which, as its name suggests, has focused primarily on cryptocurrency.2 The Report explains that "digital assets" is used as an umbrella term, which includes but is not synonymous with cryptocurrencies. This term also recognizes new forms of high value digital assets such as non-fungible tokens ("NFTs"), which are unique identifiers marking the ownership of digital goods often modeled after trading cards and often associated with a piece of digital artwork with unique identifiers, as opposed to units of digital currencies that are meant to be interchangeable.
Another notable aspect of this Report is DOJ's approval of the recent enforcement actions by the U.S. Securities and Exchange Commission ("SEC") focusing on digital assets. The SEC has been subject to recent criticism for its pursuit of these enforcement actions without promulgating clear guidance on what types of cryptocurrencies they view as securities within their jurisdiction. In this Report, however, DOJ signaled its approval of the SEC's approach by quoting a recent court decision finding that the Howey test—the test the SEC has stated it is using to determine which digital assets are securities—"provides a clearly expressed test" and that there is "an extensive body of case law [that] provides guidance on how to apply that test to a variety of factual scenarios."3
This Report and the establishment of the new DAC network come on the heels of increased scrutiny and criminal enforcement efforts aimed at digital asset abuse by DOJ and various federal and state agencies. Earlier this year, federal prosecutors and the SEC have brought multiple landmark cases pursuing actors in insider trading schemes involving cryptocurrencies and NFTs. (See prior client alerts on cases against Coinbase, a cryptocurrency platform, and involving an NFT insider trading scheme here and here, respectively). In August, Robinhood Crypto, LLC was fined $30 million by the New York Department of Financial Services ("DFS") for violations of certain rules related to anti-money laundering controls, transaction monitoring, and cybersecurity of customer information. (See prior client alert concerning this fine here). The establishment of the DAC network and the remainder of the DOJ's Report signals that these types of actions are likely to increase in the coming years.
1. Press Release, Office of Public Affair, Dep't of Justice, Justice Department Announces First Director of National Cryptocurrency Enforcement Team (Feb. 17, 2022), https://www.justice.gov/opa/pr/justice-department-announces-first-director-national-cryptocurrency-enforcement-team#:~:text=The%20NCET%20was%20established%20to, cybercrime%2C%20money%20laundering%20and%20forfeiture.
2. See Exec. Order No. 14067, 87 Fed. Reg. 14143, 14151-152 (Sec. 9(d)) (Mar. 14, 2022) (“The term ‘digital assets' refers to all [Central Bank Digital Currencies (CBDCs)], regardless of the technology used, and to other representations of value, financial assets and instruments, or claims that are used to make payments or investments, or to transmit or exchange funds or the equivalent thereof, that are issued or represented in digital form through the use of distributed ledger technology. For example, digital assets include cryptocurrencies, stablecoins, and CBDCs. Regardless of the label used, a digital asset may be, among other things, a security, a commodity, a derivative, or other financial product. Digital assets may be exchanged across digital asset trading platforms, including centralized and so-called decentralized finance platforms, or through peer-to-peer technologies.”).
3. SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169, 183 (S.D.N.Y. 2020).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.