The Legit Ledger Podcast Ep. 5
Cryptocurrency Sanctions with Reid Whitten and Gabe Khoury
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Listen to the original podcast released July 12, 2022 here: https://www.sheppardmullin.com/multimedia-410
In this episode of The Legit Ledger, Sheppard Mullin attorneys Reid Whitten and Gabe Khoury discuss cryptocurrency sanctions, including the role of the OFAC, the consequences of engaging in an unauthorized transaction, risk mitigation strategies for avoiding unauthorized transactions, and more.
Guests:
About Reid Whitten
Reid Whitten is the Managing Partner of Sheppard Mullin's London office, where his practice focuses on international trade regulations and investigations. He shares his time serving clients out of the Washington, D.C. office and is also Leader of the firm’s CFIUS Team. In the areas of economic sanctions, export and defense exports, CFIUS, anti-corruption and tariffs, Reid supports clients in detecting and addressing potential compliance issues as well as conducting investigations and defending against enforcement actions. He also advises on U.S. anti-dumping, anti-money laundering, and anti-boycott regulations. Reid is recognized as a thought leader on cross-border business regulations and serves as an Adjunct Professor of Law at the New College of the Humanities in London, the Université Catholique de Lille in France. and Wake Forest University in the U.S. He is also a member of Chatham House, the UK's Royal Institute of International Affairs.
About Gabe Khoury
Gabe Khoury was an associate with the Corporate Group in Sheppard Mullin's Washington, D.C. office. As Lead Associate of the Blockchain and Digital Assets team, he handled regulatory compliance issues relating to the use of blockchain technology, social media, Web3.0, video games, online gambling, virtual goods and currency, social tokens, decentralized autonomous organizations, decentralized exchanges, cybersecurity, privacy, Esports, the metaverse, money transmission, financial technologies, NFTs, and artificial intelligence. Gabe holds certifications in NFT technology, Metaverse Technologies, and Blockchain Law from the Blockchain Council.
Transcript:
Gabe Khoury:
Welcome to another episode of Legit Ledger. My name is Gabriel Khoury, the lead associate of the blockchain team at Sheppard Mullin, and today I'm your host as we continue our journey through the exciting world of blockchain-related legal issues.
Gabe Khoury:
Before we begin a quick programming note. If you've listened to and found any of our podcasts insightful, please do share and subscribe. And as always, please reach out with any comments, questions, or concerns. We look forward to hearing from you.
Gabe Khoury:
On today's episode, we'll be talking about cryptocurrency sanctions. With that introduction out of the way, let's get legit.
Gabe Khoury:
On this episode, we're joined by Reid Whitten. Reid is the managing partner of Sheppard Mullin's London office. He practices in international trade regulations and investigations. Reid supports clients in detecting and addressing potential compliance issues as well as conducting investigations and defending against OFAC enforcement actions, among many other areas of practice. He does a lot of things, and I think it's best for him to give you a little bit of a more detailed background. Reid, thank you for joining me on today's podcast.
Reid Whitten:
Happy to be here, Gabe.
Reid Whitten:
This topic is so much fun and it's really interesting to me, as a practitioner, and cool to talk with someone who is so enthusiastic about blockchain and crypto issues. So, to introduce myself a little bit, yeah, I am the managing partner of Sheppard Mullin's London office, and I do practice in the area of sanctions, but I really practice in what we call international trade. It's basically all the US regulations that sneak outside the boundary of the United States and affect international business. So that's export controls, that's customs, that's CFIUS, and that's sanctions. And so this is really part of my practice that I love. It changes all the time. Sanctions move with geopolitical machinations, they move with the world and how it changes. So I'm really interested to bring it to this area today.
Gabe Khoury:
Speaking of sanctions, Reid, I've heard of this word OFAC. What is OFAC? And what department is it under, exactly? And can you provide the listeners a brief background in what they actually do?
Reid Whitten:
I will, and I promise it'll be brief so we can get through the dry governmental organizational part and talk more about crypto and sanctions, but we should get everyone on the same page, on the same baseline. So OFAC is the Office of Foreign Assets Control, and it's an office in the US Treasury Department. And the office really, it promulgates and enforces all US economic sanctions. Now, to back up a step, sanctions, for those who we need to get on the same page, are basically economic restrictions that the US targets towards countries, or organizations, or even companies or individuals. And the idea is that the US will use its economic might to protect national security or implement its foreign policy.
Gabe Khoury:
And frequently with the term OFAC, I've heard of the SDN list. Can you tell the listeners what the SDN list is, where this could be found, and what it means to be on the SDN list?
Reid Whitten:
Absolutely. So an SDN is a specially designated national, SDN. It's one of the companies, organizations, or individuals that I was talking about before that's targeted by US sanctions. Now, remember, US sanctions don't actually limit the target. The target is often a foreign person over which the US does not have jurisdiction. What they do is they restrict US persons, which includes US banks, which includes you and me, and restrict us from transacting with that target, with that SDN. So that means the US government lists that person or that company as an SDN, it effectively cuts them off from the US system, from the US dollar, from US banks. And, as to your question about where you can find this, OFAC publishes a regularly updated list of SDNs. It's at sanctionssearch.OFAC.treasury dot something, but really a simple search for searchable SDN list should get you there.
Reid Whitten:
So, that is the two minute version of the class that I teach on sanctions. But, guessing by the title of the podcast, maybe we want to bring this around to questions about crypto and blockchain.
Gabe Khoury:
Absolutely. And that SDN list will be linked in the show notes below. But, as you said, let's talk about crypto now.
Gabe Khoury:
So one of the main talking points often touted by crypto skeptics is that crypto enables illicit activity. So, in light of that, are there any crypto-specific guidance pieces that OFAC has issued?
Reid Whitten:
Yes. And they're very interested in it, because remember the sanctions flex, as it were, comes through the fact that US banks are prohibited from transactions with sanction targets. So sanctions are really a great way for the government to cut a person off from the US dollar, cut a company off from the US dollar. But, because cryptocurrencies can, in some cases, move around anonymously and then be exchanged for dollars or other fiat currency, they jump out to OFAC as this way of doing an end run around US sanctions. And, for that reason, OFAC put out these, well, the first of what I imagine will be a regularly updated set of guidance points on crypto.
Reid Whitten:
And so, the guidance has four main points. First, it signals the Treasury is looking to actively engage with industry to come up with clearer sanctions compliance obligations. And I think that's important, Gabe, because the industry, especially when we're a technology and its use cases are still developing, still changing wildly, it can have a hand in its own regulation. OFAC's going to need to know more about how crypto works, or how it's going to work in the future, so big players in crypto have the opportunity to inform and also to help shape policy and regulations.
Reid Whitten:
Second, for companies that offer crypto-related services, the guidance offers points on internal controls. They're the standard points that we see about knowing your customers, doing your diligence, implementing compliance where possible. And this one's interesting, too, because the crypto world really prides itself on anonymity and decentralization. But a lot of crypto users get into the market through one of a very few major gateways, and those gateways are companies that exist in real life, that operate in countries with governments that regulate them. So OFAC is pushing on those pinch points to get those companies to do their diligence, to implement compliance, and not just throw up their hands and say, "Well, we don't know who any of these people are. We're just a platform." I don't think OFAC's going to be willing to accept those answers.
Gabe Khoury:
Cryptocurrency enthusiasts really enjoy that point, though. That whole not having to KYC, know your customer, procedures. That's our favorite thing.
Reid Whitten:
That's true. And this is where it's going to be really interesting, how the regulation's going to be implemented. And you and I have talked about this, and I think we will continue to, because it's going to be an interesting line to define, is how do you balance the anonymity, the decentralization, that is really the cornerstone of what's interesting about crypto against the potential for misuse and the need for some oversight so that it's not abused by bad actors?
Reid Whitten:
And it is really interesting because OFAC... Often government regulators are a little bit behind on technology, and OFAC may be just a bit, but in the third point of its guidance, they show a little bit of their crypto chops. They get into real technical obligations that the parties are going to have when they're looking at how to implement sanctions compliance. And they talk about, they define things like digital currency, digital currency wallet, virtual currency. They provide very specific guidance on how to block property of persons who are subject to sanctions.
Reid Whitten:
And then it ends with what might be seen as a bit of a threat. The guidance says we're collaborating across the US government with other agencies. So FinCEN, which looks at anti-money laundering is looking at crypto for, as you might guess, anti-money laundering uses. The Commodity Futures Trading Commission has brought enforcements against crypto companies for operating as futures commission merchants, which is... Gets a bit technical, but basically the market for futures contracts is regulated. So if you do a crypto transaction that looks like futures contract, you're probably going to want to be registered, or you're going to want to adjust how it is that you market.
Reid Whitten:
And this is where you and I, and a lot of the industry, and a lot of the regulators, are going to have these discussions over, How do we make that happen? How do we make this space for a new way of transacting, but with, I guess, new regulations? Because the old ones don't always fit.
Gabe Khoury:
Absolutely. Reid, that was a fantastic summary of the guidance. Thank you very much. So I know that, as a general matter, people that are located in the United States, including the members of the virtual currency industry in the US, are responsible for, and again, themselves, they are responsible for ensuring that they do not want to engage in unauthorized transactions, or dealings with sanctions persons or jurisdictions. But, Reid, what happens when they actually do? Is there a notification that they get into their email or something? And what practical guidance can you give to someone who's done this by an honest mistake?
Reid Whitten:
Yeah. So actually this happens pretty often. And usually, in the cases we see where there's been, an inadvertent violation of sanctions, transacting with a sanctioned party, it'll be the bank that catches it. And the bank will see it in the underlying documents and say, "Hey, you did a transaction with a sanctioned party." And there's a good possibility that a crypto exchange that's doing its diligence finds that and sends you note and says, "Hey you sold NFTs to a wallet that's sanctioned," or something like that.
Reid Whitten:
If you get some notification, or you even have some reason to think that you've transacted with a sanctioned party, there's no legal obligation to tell OFAC that. Now, of course, we're not getting into legal advice, every case is different, but there's no express regulation that says, "If you have a violation, you must disclose it."
Reid Whitten:
However, usually where there is an inadvertent violation through a transaction, the disclosure to OFAC generally helps. Now again, I got to caveat the crap out of this, because it is... We're not looking at your individual case, and we're not providing legal advice here, but OFAC would probably want to know, they probably see it as a routine matter, and it would probably help the regulators catch the sanctioned party, the bad guy, by seeing the pattern or practice of their transactions. Which means that your likelihood of being punished for something that you did inadvertently, that you didn't do systematically, that doesn't look intentional, that you didn't try to hide, and that you disclosed, is probably fairly low. So it can be corrected. But my advice, as it is in most cases, would be to seek legal counsel before you do anything about it.
Gabe Khoury:
I appreciate that little background, Reid. So, next we're going to shift to discussing the blog that we recently wrote together, which will be in the show notes below. So it was about the first ever OFAC sanction on a virtual currency mixer. Can you just provide a little brief background as to what that actually was?
Reid Whitten:
Yeah. So I'll actually let you speak to what a virtual currency mixer is, as the expert on that side of things, but on the sanctions side, basically this mixer had been used to move money for North Korea in a number of illicit activities. And really, the movement of money for North Korea is prohibited because US sanctions not only prohibit US persons from dealing with North Korea, but also evading or avoiding sanctions or involving US persons in transactions with North Korea. And Blender facilitated all of these things. But, more importantly, perhaps, tell us a bit about what Blender is.
Gabe Khoury:
Absolutely. So to provide a little background to our listeners, Blender, just generally speaking, is a virtual currency mixer. There are many. These currency mixers are operating on some blockchain, and they indiscriminately facilitate illicit transactions by confusing or converting their origin. Now, that's not the only use, but that is one use of a virtual currency mixer. So it confuses the origin, the destination, and also the counterparties.
Gabe Khoury:
Virtual currency mixers like Blender receive a variety of transaction, and ultimately spits out different cryptocurrencies in which you inserted into the mixer. And while their purported purpose is to increase privacy, like Blender’s is, they are commonly used by illicit actors, as exemplified by this OFAC sanction. But, Reid, what exactly does it mean to actually be sanctioned? Someone is on the sanctions list, what does it mean for them now?
Reid Whitten:
So, that's a great question. So that means that no US person can transact with that party. That means that any US person who uses blender.io has violated US law. And if they did so willfully, it's possible criminal violation, which has a penalty of up to a million dollars or 20 years in jail. So it's not nothing, but effectively what it does is cut it off from the legitimate, primarily Western banking and business systems. Any company or entity who's been sanctioned, even non-US banks and companies will tend to stay away from because of the risk that's inherent to it.
Gabe Khoury:
Okay. Thank you, Reid. Are there any risk mitigation strategies that some of our listeners need to know about?
Reid Whitten:
Yes. Although, again, I'd caveat this one in the way that you and I spoke about, which is that these are the best practices that are used by traditional companies and finance entities and banks. They are blocking access by sanctioned parties, detecting evasion attempts, anticipating potential threats. Doing your KYC, looking at your customers, and running diligence on them, all of that becomes more difficult in the crypto space where it is not normal to provide name, address, details to your financial institution where those anti-money laundering and customer checks can be run.
Reid Whitten:
So, regularly screening user accounts, for instance, which is one of the best practices, is possible, but it's probably going to be limited. So you would look at maybe the wallet addresses that have been directly subject to US sanctions, and if any of those addresses appear in your customer list or in the people you've been dealing with, then you flag that, you block the wallet, the transaction, whatever it is and if your counsel suggests, then you report it to OFAC. These are the kinds of things that are best practices that have been implemented by banks in ways that are now functionally automated, and that will need to be interpreted by the crypto community and implemented in ways that there possible to do.
Reid Whitten:
And I think that you and I have a lot of discussing left about what is possible, what is absolutely necessary, and then what the government's going to accept and not accept, and how this space can grow and change and become... Fulfill the infinite possibilities that it promises, but in a way that it's not just so wildly open to abuse by criminal actors,
Gabe Khoury:
Absolutely, Reid. You are correct, we do have a lot to discuss. Although, let's save it for future.
Reid Whitten:
Alright.
Gabe Khoury:
So, Reid, before we wrap up, do you have any final practical guidance to provide these individuals or entities that are worried about these OFAC sanctions if they're operating in the crypto space?
Reid Whitten:
Absolutely. And I think the big crypto operators are getting out in front of this to the extent that they can. I think that talking with counsel is the way to go. These are problems that you can deal with under the protection of the attorney-client privilege. You can look at what you have, what you're doing, how you're operating, how you're planning to operate, and say, "All right, look, here's our risk tolerance. Here's what we want to do. What obligations are you absolutely required to meet? Is it a best practice that we meet?” Is it maybe we'd like to meet, but maybe we won't be able to. And balance what is practical and what is required, and then what it is that your company wants to do, can do, and how it wants to operate. Those balancing questions are going to be difficult, but they're going to have to be answered if crypto operators want to go successfully in this area of regulation.
Gabe Khoury:
Absolutely. So, in short, it seems like the summary is crypto platforms need to make sure to have these compliance programs that you've mentioned in place in order to avoid fines to regulators, and also make sure to consult with experienced attorneys, such as yourself. I think an experienced attorney, such as yourself, that understands a crypto space will be able to navigate these crypto platforms and users, provide them additional guidance and expertise.
Gabe Khoury:
And that's all for this week's episode. I want to thank you, Reid, and I want to thank our listeners. If you guys have any questions about the topics discussed today, please reach out to either one of us. Our contact information will be in the show notes below. Also in the show notes will be various blogs written by our blockchain team about the topics that we discussed on this episode. Please make sure to check that out, as well. Until next time, stay legit.
Contact Information:
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