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DOJ Report Calls For International Cooperation to Fight Digital Asset Crime

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On June 6, Attorney General Merrick Garland (“AG”) issued a report titled “How to Strengthen International Law Enforcement Cooperation For Detecting, Investigating And Prosecuting Criminal Activity Related To Digital Assets” (the “Report). Led by the Department of Justice, the Report represents a collaborative effort with feedback from the Department of State, Department of Treasury, Department of Homeland Security, Securities and Exchange Commission, and Commodities Future Trading Commission (“CFTC”). The Report also comes as U.S. senators Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y. recently introduced a sweeping bipartisan bill to bring clarity to cryptocurrency regulation by defining most digital assets as commodities (to be regulated primarily by the CFTC) and enacting rules governing stablecoins.

The Report was required by President Biden’s March 9, 2022 Executive Order, Ensuring Responsible Development of Digital Assets, on which we previously blogged.  The Executive Order addressed concerns about the growing role of digital assets in money laundering crimes and sanctions evasion, and called for a report to be published by the AG for the purpose of strengthening international law enforcement cooperation.  The resultant Report stresses the pragmatic problems facing cross-border investigations – particularly the reluctance or sheer inability of foreign jurisdictions to tackle such investigations independently – and makes three basic recommendations, all of which relate to improved funding, communication and standards.

The Potential Illicit Uses of Digital Assets

The Report delves into how digital assets can be used in furtherance of criminal activity. Annex A of the Report specifically focuses on money laundering; ransomware; fraud and theft; narcotics trafficking; human trafficking; terrorism financing; sanctions evasion; and tax evasion.  Although these are all key topics, we briefly note here money laundering, fraud and tax evasion.

The Report finds that criminals are eager to launder money using digital assets because it allows them to avoid large cash transactions or other suspicious activity that would likely get their accounts flagged or frozen if they were transacting through a traditional bank. Criminals have become quite adept at using the blockchain, and now employ several techniques, including “chain hopping,” which converts transactions into differing cryptocurrencies and switches blockchains quickly, leaving a complicated trail that is very hard to trace without substantial resources. The Report provides an estimate that over $33 billion in cryptocurrency has been laundered since 2017.

Digital assets also are used in a variety of fraud schemes, such as theft of investor funds, Ponzi schemes, so-called “romance” scams and other cons. Romance scams occur when a fraudster assumes a fake online persona and convinces a victim to purchase digital assets and transfer them to the fraudster. In 2021, the FBI’s Internet Crime Complaint Center received thousands of public complains totaling over $429 million in losses from victims of these types of scams. Another lucrative scam is a “rug pulls,” where criminals adept at development create new tokens and pitch them to investors. As soon as investors pour money into the new tokens, the criminals transfer the money and disappear (leaving the value of the tokens to tank). This scam exemplifies how criminal actors can leverage and exploit the culture of innovation surrounding digital assets – especially because many people do not grasp a full understanding of the technology and risks involved.

Finally, there is a growing trend for criminals to use digital assets to avoid paying taxes. Of course, individuals and entities are legally required to report all income received through digital assets on their tax returns. However, the perception of digital assets as being “pseudonymous” and untraceable leads many to believe that they can avoid reporting such income.  Again, transactions and income can be traced and identified – given sufficient investigatory attention resources.

International Cooperation and Investigatory Hurdles

The Report’s main focus is how to successfully investigate, prosecute and prevent the criminal misuse of digital assets at an international level. The Report makes it clear that domestic interventions are not sufficient on their own, because the very infrastructure of digital assets is designed to transcend traditional borders.

The Report suggests that digital assets pose a unique risk to law enforcement on a global scale.  Although Annex B of the Report sets forth various examples of successful cross-border collaboration on digital asset investigations, the Report more importantly describes the significant and “recurring set of challenges attributable to the unique features of cryptocurrencies” which can beset cross-border investigations involving digital assets.  The Report notes the following:

  • Jurisdictional Arbitrage. Jurisdictional arbitrage in this context refers to the ability to find and exploit the gaps among international laws and regulations surrounding digital assets, money laundering and cybercrime. For example, many countries have not implemented the global standard on anti-money launder and combating the financing of terrorism (“AML/CFT”) issued by the Financial Action Task Force (“FATF”), which means that their laws may not require exchanges or VASPs to conduct sufficient KYC – which is obviously problematic from an investigatory standpoint. From an enforcement standpoint, another gap exists with respect to asset-seizure authority outside of criminal prosecutions. The U.S. often utilizes its civil forfeiture authority in the digital currency space which, among other things, allows it to act quickly and target assets that may otherwise be hidden by the time a verdict comes down. Governments lacking this power would have to wait for a conviction before seizing digital assets.
  • Speed of Transactions. The nature of transactions involving cryptocurrency makes them ideal for criminals, as they can occur instantaneously and leave very little evidence behind. While the ledger technology existing on the blockchain is immutable, the ancillary components of digital asset transactions – like the servers and methods of communication involved – are able to be deleted or hidden from law enforcement. To trace crimes involving digital assets, law enforcement needs to quickly obtain evidence.  However, obtaining records from VASPs located abroad is anything but expeditious. Requests for such records usually take the form of either “formal” or “informal” requests – the former being government-to-government pursuant to a bilateral treaty, and the latter being from U.S. law enforcement to the record-holder directly, in hopes that the record-holder’s policy is to volunteer information. Neither approach is ideal to allow for swift evidence-gathering.
  • Cost/Benefit. Investigatory tools used in the digital asset space, such as blockchain analytic tools, are expensive to onboard and maintain. While these tools are often critical in gathering evidence to prosecute crimes, not every jurisdiction will be able to afford them. It therefore is not clear that every country will have the same ideas about digital asset crimes being a top priority for law enforcement – and for jurisdictions grappling with limited resources, it may be difficult to garner public support to tackle these issues.

Recommendations

The Report conveys a sense of urgency with its call to action: meaningful interventions to stop digital asset crimes require international cooperation. The Report posits three specific recommendations needed to combat digital asset crimes on the global scale:

  • Strengthen U.S. agencies’ existing operational and capacity-building  initiatives with foreign law enforcement partners;
  • Deepen information sharing partnerships and improve coordination between U.S. law enforcement agencies and their foreign counterparts; and
  • Promote robust compliance with international AML/CFT standards to reduce the risks posed by jurisdictional arbitrage.

As to the first recommendation, the Report urges in part that U.S funds be allocated to international law enforcement partners – coupled with an increase in the capacity and crypto-related expertise of U.S. law enforcement to deliver assistance abroad.  As to the second recommendation, the Report stresses the importance of information sharing in maximizing speed and coordination in cross-border investigations.  When addressing the issue of jurisdictional arbitrage, the Report recommends that countries work toward meeting FATF’s global standards on AML/CFT, and notes that most jurisdictions fall short of having proper standards in place – including as to the “real world” implementation of the Travel Rule to VASPs.

If you would like to remain updated on these issues, please click here to subscribe to Money Laundering Watch.  Please click here to find out about Ballard Spahr’s Anti-Money Laundering Team.

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