TREASURY AND DOJ SIGNAL TOUGH REGULATION AND STRICT ENFORCEMENT

On September 16, 2022, the U.S. Department of the Treasury ("Treasury"), the Department of Justice (the "DOJ"), and other U.S. government agencies released eight highly anticipated reports1 (the "Reports") on different aspects of digital asset regulation, setting forth the agencies' respective legislative, regulatory, and policy recommendations and priorities. The Reports were issued in response to White House Executive Order 14067 on Ensuring Responsible Development of Digital Assets (the "Executive Order"), which calls for a whole-ofgovernment alignment of the federal government's approach to digital assets.

The Reports confirm the Biden-Harris Administration's acknowledgement that digital assets have potential benefits and are likely to remain a component of the U.S. financial system, but that the proliferation of the asset class presents unique risks that should be addressed. While the Reports provide some insight into the Administration's thinking about digital assets and articulate some recommendations and "calls to action," many significant regulatory questions remain unaddressed.

This Winston Alert highlights the most significant aspects of the Reports, including:

  • Regulatory and procedural reform: The Reports call for coordination among federal agencies to increase regulation of digital assets, pursue investigations of misuse, issue plain-English reports to increase digital asset literacy, and amend anti-money laundering ("AML") and money transfer laws to apply to digital assets.
  • Illicit activity, money-laundering, and terrorism financing risks: The Reports emphasize the risks posed by digital assets for domestic and international AML programs and efforts to counter terrorism financing. The pseudonymity, irreversibility of transactions, and current information asymmetry between issuers of digital assets and consumers and investors create an environment conducive to illicit activity that may harm U.S. consumers, businesses, and investors.
  • Populations vulnerable to disparate impacts of digital assets: The Reports discuss the delicate balance between the potential benefits of digital assets for unbanked and underbanked populations and the risks they pose for these groups. While these groups stand to benefit from new technologies, they may also be disparately vulnerable to their misuses. 
  • Populations vulnerable to disparate impacts of digital assets: The Reports discuss the delicate balance between the potential benefits of digital assets for unbanked and underbanked populations and the risks they pose for these groups. While these groups stand to benefit from new technologies, they may also be disparately vulnerable to their misuses.
  • U.S. central bank digital currency exploration: Treasury recommends further study of the risks and benefits of a central bank digital currency in the United States, while also suggesting that one is not imminent in the United States and may be determined not in the best interest of the American people

ACTION PLAN TO ADDRESS ILLICIT FINANCING RISKS OF DIGITAL ASSETS (U.S. DEPARTMENT OF THE TREASURY)

Treasury published its "Action Plan to Address Illicit Financing Risks of Digital Assets" ("Action Plan") as mandated by Section 7(c) of the Executive Order, which directed the development of a coordinated interagency action plan for "mitigating the digital asset-related illicit finance and national security risks addressed in the updated strategy." In the Action Plan, Treasury identifies several aspects of digital assets that are of concern for Treasury, including the use of digital assets in money laundering, ransomware crimes, revenue generation and sanctions evasions by states and groups, and financing of terrorist organizations. As a result, Treasury presented seven "priority actions" and supporting actions to address these issues.

FEATURES OF DIGITAL ASSETS

Treasury identified several features of digital assets and digital asset businesses that pose risks to proper financial security and oversight, including:

  • Gaps in AML regimes across countries;
  • Anonymous features of digital assets;
  • Disintermediation of virtual assets, actual or otherwise; and
  • Virtual asset service providers ("VASPs") that are non-compliant with AML and other regulatory obligations.

Treasury focused on the obligations of VASPs and peer-to-peer ("P2P") service providers who engage in the business of transacting digital assets through "unhosted" digital wallets–i.e., wallets not held by any financial institution or VASP. Treasury stated that VASPs and P2P service providers can be subject to U.S. AML obligations if they operate wholly or in substantial part in the United States, regardless of where they are located. Such businesses and individuals could be required to register with the Financial Crimes Enforcement Network ("FinCEN") as money services businesses, implement an effective AML program, or abide by recordkeeping and reporting obligations such as the requirement to file Suspicious Activity Reports ("SARs"). Treasury also warned that P2P service providers and decentralized finance ("DeFi") services that purport to transact through unhosted wallets may nonetheless be subject to AML and countering-the-financing-of-terrorism ("CFT") obligations as money transmitters when they transfer currency, funds, or assets of value.

PRIORITY AND SUPPORTING ACTIONS

Treasury introduced seven priority actions to mitigate the perceived threats and risks of digital assets. In most of the supporting actions to these priorities, Treasury identified itself as the lead department to pursue the objectives, while also recognizing the importance of interagency coordination. The priority actions listed in the Action Plan are:

  • Monitoring emerging risks through collection of information and investing in technology and training;
  • Improving global AML regulation and enforcement;
  • Updating Bank Secrecy Act ("BSA") regulations to address illicit financing risks;
  • Strengthening U.S. AML supervision of virtual asset activities and promoting standardization of AML/CFT obligations across states;
  • Holding accountable cybercriminals and other illicit actors through seizures, criminal prosecutions, civil enforcement, and targeted sanctions designations;
  • Engaging with the private sector and exchanging information on illicit financing risks and AML obligations; and
  • Supporting U.S. leadership in financial and payments technology, such as real-time payment solutions and stablecoins

While most of the supporting actions were continuations of Treasury's previous work, some of the supporting actions were new. For example, Treasury intends to publish an illicit finance risk assessment on DeFi and its role in money laundering and terrorist financing risks by February 24, 2023. Treasury also plans to convene state supervisors to promote standardization and coordination of state licensing and AML obligations of VASPs. Furthermore, Treasury briefly noted the increasing global interest in Central Bank Digital Currencies ("CBDC"), which Treasury believes must be designed to comply with global AML standards. Treasury plans to monitor both domestic and foreign CBDC development initiatives and consider implications for AML/CFT controls.

Footnotes

1. The complete Reports mandated by President Biden's Executive Order and issued by Treasury, DOJ, and White House explored in this Winston Alert can be located at the following links:

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