Insights
This week in the UK is dedicated to our future leaders with National Apprenticeship Week. As such, we are looking at our future lawyers – always inspiring and good to see the enthusiasm and talent that there is out there.
DAC Beachcroft is leading the way in this area with a robust apprenticeship programme. Read about Karrie Mead‘s experience below.
Click on the link to read about our Early Talent opportunities – https://bit.ly/48DBhIi
Stratton Horres (Senior Counsel-Dallas, TX) and frequent co-author, attorney David Steiger, have weighed in on the hotly debated subject of the use of Artificial Intelligence (AI) in the legal market. Their article, “Where the Rubber Hits the Road: Practical AI Solutions Are Coming to the Legal Market,” appeared on April 4, 2023, in Reuters Legal News and Westlaw Today. The authors contend, “What is driving adaptation of increasingly sophisticated AI into the business of law is the tremendous savings in time and money that result from ridding old processes of unnecessary duplication of effort and the value add that comes from leveraging the power of ever-growing amounts of data.” They also highlight some of the most promising AI products for law firms currently available.
Congratulations to DAC Beachcroft LLP who have been nominated as cyber law firm of the year in the Zywave Cyber Awards in New York !
Tomorrow at Zywave Cyber Risks Insights conference, Hans Allnutt will be moderating a panel of fellow Legalign Global™ cyber experts, Wotton + KearneyNicole Gabryk & DAC Beachcroft FranceChristophe Wucher-North, along with Sandra ColeBeazley & Ernie KoschinegCIPRIANI & WERNER PC discussing Cyber Litigation and Regulation.
See below how to vote for DACB’s cyber team.
#cyber#litigation#lawfirm#litigationandregulation#nomination#awards#cyberawards#event#cyberevent#zywave
Being proud to be part of the team and the buzz of the worldwide team spirit are just a few of the things that Christophe Wucher-North of DAC Beachcroft France enjoys about being part of a global alliance.
Continuing our People Behind the Suits Interview series, Christophe tells us about his career trajectory to date, being a partner of DAC Beachcroft in Paris from its inception, what drew him to the profession in the first place and amongst other things, what he’d be if he weren’t a lawyer and it’s a pretty big change ! But tellement français – oui oui bonjour as Sylvie from ‘Emily in Paris’ would say…
Tell us about your journey to becoming a partner at DAC Beachcroft France
It was a very exciting step to move from my former French firm to open the Paris DACB office in 2019 with my business partner . It all came about at the right time and quite organically as we realized that our work and our clients were totally aligned. In fact, our first contacts with DACB have been organized thanks to existing relationships with a mutual client!
What made you decide to become a lawyer?
It was a toss up between becoming a lawyer or a judge although it is a totally different academic route! Actually, in France you have to decide very early on as the training courses are very different. But it became quite clear to me that being a lawyer would be personally and intellectually more challenging.
What do you think is a major issue facing your area in insurance law?
Keeping abreast of the innovative approaches in the insurance market in order to understand the clients’ needs and to help them to solve specific problems from outside their own organization.
What’s the best piece of advice (work or personal) that you have been given?
To keep going and never give up!
What do you enjoy most about being part of a global alliance ?
Our global team spirit …
What do you get up to outside of the office?
I like to learn new things, enjoy my hobbies and spending time with my family.
Complete this sentence – If I weren’t a lawyer, I would be…
A famous writer ! Well, I always dreamt about it …
And why not we say !
‘The people you work with are often more important than the work you do – make sure you surround yourself with a supportive team and environment’
Great advice given to Nicole Gabryk, a key member of Legalign’s Cyber team at Wotton + Kearney in Sydney, who kickstarts our new People Behind the Suits Series interview. Nicole shares her backstory, what attracted her to the profession and other fascinating insights, including who would play her in a Netflix version of Legalign…
Nicole will be speaking on panel at the Zywave Cyber Risk Insights conference in London on Wednesday 19th April – there’s is still time to register for tickets http://bit.ly/3mwO5hn
Tell us about your journey to becoming a partner at Wotton + Kearney.
I moved from South Africa to Australia in late 2021 and requalified in a new jurisdiction (after practicing as a lawyer in South Africa for over 10 years). I have been working in cyber insurance and data protection since 2015 (at which stage the area of law and insurance was very much in its infancy) and have focused on understanding the unique challenges faced by our insurance clients as a result of the ever-growing cyber risks in the Australian market. I have been very fortunate to be surrounded by brilliant colleagues who supported my career progression to become a partner in a niche and emerging field of law.
What made you decide to become a lawyer?
I was always interested in the legal profession and how law was a field that was able to shape society. Cyber Insurance and privacy law is a new field and a fantastic area of law to be involved in as it adapts and responds to newly emerging digital challenges.
What do you think is a major issue facing your area in insurance law?
Each month the cyber landscape seems to shift – threat actors get more sophisticated and new laws are enacted (or adapted) to protect individuals in the digital era, the challenges facing cyber insurers continue to evolve – this includes everything from increased third party risks (for example higher regulatory penalties and more class action lawsuits), increased first party and business interruption costs resulting from cyber incidents and more complex regulation for insureds.
What’s the best piece of advice (work or personal) that you have been given.
The people you work with are often more important than the work you do – make sure you surround yourself with a supportive team and environment.
What do you enjoy most about being part of a global alliance
The ability to share knowledge and insights with my fellow Legalign colleagues to ensure that we are keeping up to speed with global trends that impact the insurance industry, which in turn helps me provide more informed advice for local Australian clients.
What do you get up to outside of the office
I love being outdoors with my family – we love to go fishing, head out on the boat or to the beach
Complete this sentence – If I weren’t a lawyer, I would be…
amazed to have so much time on my hands… and hopefully use that time to be off travelling to new places (so much to see, so little time)
If Legalign were a fictional law firm on Netflix, who would play you ?
As a career in law can sometimes resemble The Hunger Games … I would go with Jennifer Lawrence
The recent implosion of crypto firm FTX and its affiliates provides a case study for potential crypto exposure under traditional insurance policies in this series of four articles: Silent Crypto for D&O and Corporate Liability Insurance (Part I), Silent Crypto Exposure for Accountants (Part II), Silent Crypto Exposure for Lawyers (Part III), and Crime and Custody Coverage for Crypto Assets (Part IV).
Crime and Custody Coverage for Crypto Assets
Dollars are fungible with each other. And so it’s not like there’s this $1 bill over here that you can trace through from start to finish. What you get is more just omnibus, you know, pots of assets of various forms.
– Sam Bankman-Fried1
The recent collapse of the once highly lauded FTX cryptocurrency exchange and its affiliated entities has resulted in the inexplicable disappearance of billions of dollars of investor funds and crypto assets that seemingly vanished into thin air overnight. These events shine a spotlight on the potential exposure related to the loss or theft of funds, cryptocurrencies or other digital assets held by crypto firms or third parties.
OCC Softens Stance on Banks’ Cryptocurrency Activities
In the past few years, the U.S. Office of the Comptroller of the Currency (OCC) has issued a series of interpretative letters and guidance regarding the agency’s loosening stance on banks engaged in cryptocurrency activities.
First, OCC confirmed that banks may provide cryptocurrency custody services to customers by holding the “unique cryptographic keys associated with cryptocurrency.”2 OCC explained that cryptocurrencies are held in “wallets” that store the cryptographic keys associated with digital currency. These can be “hot” wallets connected to the internet or “cold” wallets, which are completely offline and considered more secure from hacking.
The digital currencies reside on a blockchain, also known as distributed-ledger technology (DLT). To authorize transactions involving cryptocurrencies or other digital assets, individuals must use their private cryptographic key. These private keys are sacred, and if they are lost or stolen, individuals lose all access to their digital assets. OCC observed that such custodial services are merely a modern-day expansion of banks’ traditional role of safekeeping and custody of assets.
Second, OCC has indicated that banks also may hold reserves to support “stablecoin” transactions.3 Stablecoin are digital coins backed by another asset such as a fiat currency (for example, the U.S. dollar) and, hence, considered less volatile than other cryptocurrencies. In particular, OCC noted that stablecoin issuers might want to place the cash reserves backing their stablecoin with a national bank. In that case, banks should have contractual agreements in place with the coin issuer to verify that the value of the deposit balances held in reserve by the bank are equal to or greater than the value of the stablecoins at any given time.
Third, OCC has authorized banks to participate in cryptocurrency transactions based on blockchain or DLT, including independent node verification networks (INVNs).4 By way of background, OCC observed that the “primary role of banks is to act as financial intermediaries” in the financial markets and payment systems. In this role, banks may “facilitate the exchange of payments and securities” and “settle transactions” for parties.5
With advances in technology and the global financial markets, there is “increasing demand in the market for faster and more efficient payments through the use of decentralized technologies, such as INVNs, which validate and record financial transactions, including stablecoin transactions.”6 As such, the OCC has concluded that a “bank may validate, store and record payments transactions by serving as a node [or participant] on an INVN.”7
However, in all financial transactions involving cryptocurrencies, OCC has emphasized that banks still are required to abide by Anti–Money Laundering (AML) and Bank Secrecy Act (BSA) compliance requirements, given the heightened risks posed by such transactions. In particular, “a bank should specifically address risks associated with cryptocurrency activities, including, but not limited to, operational risk (e.g., the risks related to new, evolving technologies; the risk of hacking, fraud and theft; and third-party risk management), liquidity risk, strategic risk, and compliance risk.”8
OCC’s softer stance on cryptocurrency activities by banks has opened the door for traditional financial institutions to participate in a limited capacity. In October 2022, the nation’s oldest bank, BNY Mellon, announced the launch of its Digital Asset Custody platform to hold and transfer Bitcoin and Ether (ETH) for select clients.
Don’t Count on FDIC Insurance for Crypto Assets
Notwithstanding the OCC’s blessing bestowed on banks engaged in cryptocurrency transactions, the Federal Deposit Insurance Corporation (FDIC) has made it abundantly clear that FDIC insurance does not apply to financial products such as “crypto assets” or other types of securities or commodities.9 Moreover, FDIC insurance “does not protect against the default, insolvency, or bankruptcy of any non-bank entity, including crypto custodians, exchanges, brokers, wallet providers, and neobanks.”10
In short, FDIC insurance only applies to (1) deposits held by insured banks and savings associations and (2) only in the unlikely event of an insured bank’s failure.11 In other words, FDIC insurance might cover USD held in reserve by an insured bank to back a stablecoin, but would not apply to the collapse of a crypto firm or exchange – such as FTX or its sister company Alameda Research – holding, buying, selling or trading cryptocurrencies for customers.
Vault & Wallet Insurance for Digital Assets
In growing recognition of the need for insurance as a risk management tool for cryptocurrency and digital asset custodial services, insurance companies are slowly wading into the market with new and innovative products. Not surprisingly, the London insurance market – with its history of insuring difficult to place risks and capacity, along with its ability to allocate, and hence reduce, exposure among line slip insurance market participants – was one of the first to jump into the fray.
For instance, in 2020, a consortium of Lloyd’s syndicates launched a liability policy to protect against losses arising from the theft of cryptocurrency held in “hot” (online) wallets. Moreover, this insurance product provided a dynamic limit of liability that fluctuated with the increasingly volatile price of crypto assets.12 In October 2022, another Lloyd’s syndicate announced a $50 million insurance policy for digital assets held in “cold” (offline) storage by a designated institutional custodian.13 More recently on November 28, 2022, a digital asset custody platform announced that it had partnered with an insurance company to provide up to $1 billion of coverage for clients that stored their digital assets in the platform’s offline cold vault.14
However, thus far, dedicated insurance solutions for the crypto market appear to be limited in terms of the type of coverage (such as vault insurance) to a select group of regulated banks and market participants, as underwriters try to wrap their heads around the potential exposure in the wake of the FTX collapse and multibillion-dollar losses.
Commercial Crime Coverage
The loss of billions of dollars of assets held by FTX shines the spotlight on potential insurance available under traditional Commercial Crime policies. Such policies typically afford coverage for the loss of assets by the insured due to theft by an agent or employee of the firm. These assets may include money, securities or other tangible property.
The classification of digital assets in the context of a crime policy is somewhat hazy. On one hand, the SEC has taken the position that most cryptocurrencies are “securities.” On the other hand, the IRS treats digital assets as “property” for tax purposes. The IRS notes that digital assets may include convertible virtual currency and cryptocurrency, stablecoins and non-fungible tokens.15 Of course, most would agree that these digital assets are not “tangible” property under a crime policy.
To further complicate matters, the Financial Crimes Enforcement Network (FinCEN) has issued interpretative guidance indicating that money services businesses (MSBs) engaged in “money transmissions” involving “convertible virtual currencies” (CVCs) are subject to the Bank Secrecy Act.16 According to FinCEN, a CVC “is a type of virtual currency that either has an equivalent value as currency or acts as a substitute for currency.”17 Under FinCEN guidance, one might argue that a so-called “money transmission” or transaction involving any type of virtual currency involves “money” in the broadest sense – which may include both “traditional currency”18 and “virtual currency.”
To avoid confusion regarding the scope of coverage under a crime policy, such policies may be amended or endorsed to specifically include cryptocurrency or digital assets. Of course, various policy exclusions still may preclude coverage for the theft or disappearance of assets. For instance, crime policies may exclude coverage for any theft or other fraudulent, dishonest or criminal act by the insured organization’s directors and officers. In the case of FTX, Sam Bankman-Fried (SBF), the founder, principal and former CEO of the company, is alleged to be personally responsible for the loss or theft of missing FTX customer funds and crypto assets.
On December 13, 2022, the Department of Justice unsealed a criminal indictment against SBF charging him with counts of conspiracy to commit wire fraud, commodities fraud, securities fraud, money laundering and violation of U.S. campaign finance laws.19 Thus, while crime policies may offer an added layer of protection for companies, they will not insure against intentional, knowing theft and misconduct committed at the highest levels of the organization.
Conclusion
To avoid “silent crypto” exposure under traditional insurance policies, carriers should consider asking some basic underwriting questions such as the following:
- Do the company’s business activities include transactions involving cryptocurrencies or other digital assets?
- Does the company issue, buy, sell, trade or lend cryptocurrency, coins, tokens (including NFTs) or other digital assets?
- Does the company hold cryptocurrency or other digital assets in custody?
- Does the company accept or exchange cryptocurrency or digital assets as payment for goods or services?
- Is the company registered with the SEC, Commodity Futures Trading Commission (CFTC) or other state or federal regulators with oversight of the financial markets?
- Is the company licensed as a money services business (MSB) with FinCEN/ U.S. Department of the Treasury?
- Is the company licensed in any states as a money transmitter business (MTB)?
- Is the company subject to the Bank Secrecy Act (BSA) and Anti–Money Laundering (AML) laws?
- Did the company report any cryptocurrency or digital asset transactions (including income, capital gains or losses derived from such transactions) in its IRS tax filings?
- Does the company’s accountant conduct full or partial audits or proof of reserve checks of any cryptocurrencies and digital assets held by the firm?
For more information about this article or related topics involving cryptocurrency and digital assets, please contact Anjali C. Das, Partner and Co-Chair of Wilson Elser’s national Cybersecurity & Data Privacy Practice ([email protected]).
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1 As told by former FTX CEO, Sam Bankman-Fried to the Wall Street Journal, “FTX Founder Can’t Explain Lost Billions” (December 3, 2022).
2 OCC Interpretative Letter #1170 (July 2020).
3 OCC Interpretative Letter #1172 (October 2020).
4 OCC Interpretative Letter #1174 (January 2021).
5 Id.
6 Id.
7 Id.
8 OCC Interpretative Letter #1179 (November 2021).
9 FDIC Fact Sheet: “What the Public Needs to Know About FDIC Deposit Insurance and Crypto Companies.”
10 Id.
11 Id.
12 “Lloyd’s launches new cryptocurrency wallet insurance solution for Coincover” (February 28, 2020).
13 “Matrixport secures USD 50M insurance coverage for digital assets held with Cactus Custody from Canopius” (October 3, 2022).
14 “GK8 increases insurance cap on digital assets to $1B” (November 28, 2022). Article found at https://cointelegraph.com/news/gk8-increases-insurance-cap-on-digital-assets-to-1b.
15 https://www.irs.gov/businesses/small-business-self-employed/digital-assets#.
16 FinCEN Guidance: Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies, FIN-2019-G001 (May 9, 2019).
17 Id.
18 31 CFR § 1010.100(m) defines “currency” as: “coin and paper money of the United States or any other country that is designated as legal tender and that circulates and is customarily used and accepted as a medium of exchange in the country of issuance.” Such currency is also referred to as “fiat” currency. As noted by the IRS, “digital assets are not real currency (also known as ‘fiat’) because they are not the coin and paper money of the United States or a foreign country and are not digitally issued by a government’s central bank.” See IRS: Digital Assets at https://www.irs.gov/businesses/small-business-self-employed/digital-assets#.
19 (Unsealed) Indictment in United States v. Samuel Bankman-Fried, 22-Crim-673 in the U.S. District Court for the Southern District of New York.
The recent implosion of crypto firm FTX and its affiliates provides a case study for potential crypto exposure under traditional insurance policies in this series of four articles: Silent Crypto for D&O and Corporate Liability Insurance (Part I), Silent Crypto Exposure for Accountants (Part II), Silent Crypto Exposure for Lawyers (Part III), and Crime and Custody Coverage for Crypto Assets (Part IV).
Silent Crypto Exposure for Lawyers
Like other professional services providers, lawyers are not immune from potential liability exposure in connection with providing legal advice and services to crypto firms as the regulatory landscape continues to evolve in a choppy and uncertain fashion. Indeed, more firms and participants in the burgeoning ecosystem for blockchain, cryptocurrency and digital assets are engaging lawyers as a hedge against their own potential liability exposure as it becomes increasingly clear that there will be greater regulatory oversight and scrutiny of crypto firms doing business in the United States and abroad.
Many law firms purchase Lawyers Professional Liability (LPL) insurance policies, which typically afford coverage for claims first made against attorneys in rendering professional legal services to clients for a fee. These claims frequently are brought by the law firms’ clients in the form of a legal malpractice lawsuit alleging negligence, errors or omissions in rendering (or failing to render) appropriate legal services or advice. Carriers issue policies based on the area of law in which the applicant attorney typically practices, which may be broad, but all policies contain exclusions that must be reviewed. Attorneys may purchase LPL policies that afford expanded coverage for legal services provided by lawyers acting in a fiduciary capacity or providing investment advice. This is particularly noteworthy where the lines of law, business, finance and investments may blur.
The insurance market also offers a specialized product known as Employed Lawyers coverage, which is typically added by endorsement to corporate D&O policies or Management Liability Insurance policies. This coverage is intended to insure the acts, errors or omissions of in-house corporate counsel – but solely in connection with rendering legal services in their capacity as an employee of the insured organization.
Recent events in the crypto markets, including the fall of the fourth-largest crypto exchange, FTX, highlight the various unresolved legal issues that can trip up attorneys who provide advice to individuals or entities engaged in creating, buying, selling, trading, lending, retaining custody or other transactions involving cryptocurrency or digital assets.
Some legal issues that have caught crypto firms and their lawyers off guard include:
- Appropriate legal structure of the entity
- Where the entity should be domiciled
- Constantly evolving global regulatory landscape for crypto firms and digital assets
- Whether the firm should be registered or licensed to transact business in different jurisdictions
- Whether the firm is subject to oversight by the Securities and Exchange Commission (SEC) for dealing in “securities”
- Whether the firm is subject to oversight by the Commodity Futures Trading Commission (CFTC) for dealing in “commodities”
- Whether the firm is a “money services business”
- Whether the firm is subject to the Bank Secrecy Act and anti–money laundering laws
- Whether the firm’s customer Terms of Service are appropriate and being followed
- Tax treatment for cryptocurrencies and digital assets
- The attorney’s personal interest in the firm as an investor, shareholder or stakeholder
- Whether attorneys have appropriately (or correctly) advised individual directors or officers about potential personal exposure.
Lawyers who intend to provide such advice should be careful to set client expectations in this uncertain and largely untested legal environment for crypto firms, keep abreast of new developments, and recalibrate legal advice and recommendations as the regulatory landscape evolves.
For more information about this article or related topics involving cryptocurrency and digital assets, please contact Anjali C. Das, Partner and Co-Chair of Wilson Elser’s national Cybersecurity & Data Privacy Practice ([email protected]).
The recent implosion of crypto firm FTX and its affiliates provides a case study for potential crypto exposure under traditional insurance policies in this series of four articles: Silent Crypto for D&O and Corporate Liability Insurance (Part I), Silent Crypto Exposure for Accountants (Part II), Silent Crypto Exposure for Lawyers (Part III), and Crime and Custody Coverage for Crypto Assets (Part IV).
Silent Crypto Exposure for Accountants
Given the collapse of FTX and other crypto firms, it is imperative that accountants and tax professionals familiarize themselves with the existing regulations and official positions the SEC and IRS have taken with respect to cryptocurrency and digital assets. Digital currency continues to be an increasingly popular asset and is changing the norm of traditional accounting practices. The varying treatments of cryptocurrency require accountants of corporate taxpayers in particular to pay closer attention to the best practices of how to treat cryptocurrency and how to calculate capital gains and losses based on that treatment.
FTX’s (Unreliable) Audited Financial Statements
The fourth largest crypto exchange, FTX, has faced a public and sudden decline, creating major implications in the cryptocurrency world. Surprisingly, prior to its collapse, FTX received a clean bill of health from two accounting firms that reportedly conducted comprehensive audits under Generally Accepted Accounting Principles (GAAP). One of these firms markets itself as one of the first-ever CPA firms to operate in the Metaverse.
That aside, in recent FTX bankruptcy filings, the company’s new CEO has cautioned stakeholders not to depend on FTX’s audited financial statements as a reliable indication of the company’s financial condition. The bankruptcy filings further note that FTX did not keep appropriate books and records or security controls with respect to digital assets. Accordingly, the FTX debtors have engaged forensics analysts to identify potential FTX assets on the blockchain. Nonetheless, FTX’s accountants reportedly stand by their audit opinions and have suggested that the events leading up to the company’s demise post-dated the audits. Critics observe that one of the weaknesses in the audits was the fact that they did not address the effectiveness of FTX’s internal financial controls, which might have contributed to its failure.
FTX was one of the few crypto firms that actually conducted GAAP audits, most do not. Unlike publicly traded companies, private companies are not required to publish or audit their financial statements. Some crypto firms try to reassure investors by conducting proof-of-reserve checks, which provide limited information to verify that assets are held in customer accounts.
The Murky World of Proof of Reserves for Crypto Firms
In an effort to alleviate customer and investor fears following the collapse of FTX, other crypto firms and exchanges such as Binance are hiring accounting firms to provide partial audits of cryptocurrencies and digital assets held by these firms. Notably, many of these entities are not publicly traded U.S. companies, and therefore are not legally required to file full audited financial and accounting statements in compliance with GAAP. To take advantage of this, crypto firms such as Binance are increasingly requesting independent accounting firms to provide non-GAAP “proof of reserves” reports, which are intended to verify the value of customer funds and digital assets held in custody.
To be clear, these limited proof-of-reserve reports are a far cry from audited financial statements and routinely fail to address the effectiveness of a company’s financial reporting controls. This is a significant omission when recalling the fact that the Sarbanes-Oxley Act of 2002 (SOX) was enacted by Congress in the wake of high-profile corporate accounting scandals involving companies the likes of Enron, WorldCom, Adelphia and Tyco. In particular, section 404 of SOX requires management and the external auditor to report on the adequacy of the company’s controls over financial reporting. Moreover, section 302 of SOX requires senior officers to personally certify in writing that the company’s financial statements fairly present in all material respects the company’s financial condition and operations. Corporate officers may be subject to harsh criminal penalties and jail time for knowingly providing false and misleading certifications.
Documenting and testing a company’s internal controls for financial reporting can be exceedingly costly and time-consuming. As a result, many companies do not voluntarily undertake this task unless legally required to do so. In the case of Binance, some critics observe that the company’s proof-of-reserve report is meaningless without information about Binance’s internal controls for financial reporting.1
Tax Treatment of Cryptocurrency
Notably, the IRS treats cryptocurrency and other digital assets as property for tax purposes. In particular, the IRS notes that digital assets may include but are not limited to convertible virtual currency and cryptocurrency, stablecoins and non-fungible tokens (NFTs). Transactions involving digital assets have to be reported for tax purposes.
The IRS has indicated that taxable gains or losses may result from the following types of transactions involving digital assets:
- Sale of a digital asset for fiat currency
- Exchange of a digital asset for property, goods or services
- Exchange or trade of one digital asset for another
- Receipt of a digital asset as a payment for goods or services
- Receipt of a new digital asset as a result of mining or staking activities.2
Many crypto exchanges supply user records to the IRS for its review. These records typically include names, addresses and social security numbers, and now often include biometric identification and various identification card copies. While usually not included in the Know-Your-Customer (KYC) records sent to the IRS, the exchanges typically maintain banking information, phone numbers and various other identification information. Since many exchanges send 1099-B or 1099-K forms, individuals and corporations are likely to be audited if it is determined that the taxpayer has unreported income. As such, obtaining and submitting these forms is imperative to completing taxes.
The following steps include the basics of completing crypto taxes:
- Collect all transaction data
- Sort all transaction data into one place and determine holdings
- Compare cryptocurrency and digital asset holdings and determine if they match the final results from collecting the data
- Complete a capital loss/gains analysis
- Fill out form 1040 Schedule D. Most large exchanges provide forms that can be downloaded with all of the transaction data that exists on that exchange.
Steps 1 and 2 may need to be repeated after a review of current holdings if the total holdings discovered in the collection of data and the taxpayer’s actual holdings do not match. The IRS requires taxpayers to keep records that are sufficient to establish positions taken on tax returns.
As stated by SEC Chair Gary Gensler, cryptocurrency is a security governed by U.S. securities laws. Considering the seismic impact of recent major crypto events, such as FTX’s bankruptcy, the SEC has increased its regulatory oversight of crypto exchanges. While many cryptocurrency owners and users do not actually realize regular currency value until they sell for USD or some other currency, each transaction or payment of digital currency is income. As such, the SEC expects individuals to follow the same regulations, such as reporting receipt of cryptocurrency.
Accountants’ Professional Liability Insurance
Many accountants have errors and omissions coverage in the form of dedicated Accountants Professional Liability Insurance policies, which typically afford coverage for third-party claims, suits or demands made against the accounting firm during a 12-month policy period. Coverage is generally limited to professional services rendered by the insured as an accountant or CPA to clients for a fee. These policies were designed to cover traditional accounting functions. However, given the complexities and uncertainties regarding accounting and tax reporting for cryptocurrencies and digital assets, insurers may be on the hook for unintended exposures related to the nebulous world of crypto finance and accounting.
The Future of Cryptocurrency Accounting
Digital currency is here to stay and the implications for the economy and methods of accounting are significant. The IRS and SEC already have begun fortifying their departments to prepare for the future onslaught of investigations and audits. The SEC has investigated and fined celebrities such as Kim Kardashian for failure to disclose payment in the form of cryptocurrency for an Instagram post.
Earlier this year, the IRS issued a “John Doe” summons requiring M.Y. Safra Bank to produce information on taxpayers who are customers of sFOX, a full-service crypto prime dealer. M.Y. Safra Bank offered banking services in relation to applicable crypto transactions. With more than $12 billion in crypto transactions undertaken since 2015 by sFOX users, the IRS is using this summons to launch a full-scale and vigorous investigation into discovering tax cheats and noncompliance with tax reporting regulations.
Cryptocurrency was meant to be an unregulated currency – unaffected by inflation or market downturns and government oversight. Today, it is becoming clear that government entities will not overlook the high-value return cryptocurrency offers taxpayers, albeit in a high-risk asset. This higher risk creates concerns for the overall economic market and financial health of individuals. The high return makes cryptocurrency an ideal asset to tax and regulate. With this in mind, cryptocurrency users, exchanges and accountants that provide tax advice with respect to taxpayers’ cryptocurrency holdings need to pay attention to the changing landscape of regulations in the digital currency world.
For more information about this article or related topics involving cryptocurrency and digital assets, please contact Anjali C. Das, Partner and Co-Chair of Wilson Elser’s national Cybersecurity & Data Privacy Practice ([email protected]) or Farzana Ahmed, Associate ([email protected]).
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1 Wall Street Journal, “Binance Seeks to Calm, but Finances Still Unclear” (December 12, 2022).
2 IRS – Digital Assets at https://www.irs.gov/businesses/small-businesses-self-employed/digital-assets#.
The recent implosion of crypto firm FTX and its affiliates provides a case study for potential crypto exposure under traditional insurance policies in this series of four articles: Silent Crypto for D&O and Corporate Liability Insurance (Part I), Silent Crypto Exposure for Accountants (Part II), Silent Crypto Exposure for Lawyers (Part III), and Crime and Custody Coverage for Crypto Assets (Part IV).
Silent Crypto for D&O and Corporate Liability Insurance
The fallout from the FTX debacle highlights potential “silent crypto” exposure for insurance carriers in the evolving and largely misunderstood world of cryptocurrencies and digital assets that has duped even some of the most sophisticated investors and financial services firms.1
Many public and private companies purchase Directors and Officers and Company liability insurance coverage, also known as “D&O” and/or Management Liability Insurance. D&O policies typically provide coverage for third-party claims made against the directors and officers of a company for a Wrongful Act while acting in their official capacity as such. Wrongful Acts may broadly include any breach of duty, neglect, error, misstatement, misleading statement, omission or act by such individual. Such policies also afford coverage for third-party claims made against the company.
However, the scope of such coverage is vastly different for publicly traded companies versus private companies. In the case of a private company, coverage may extend to claims for any corporate wrongful acts or omissions. In contrast, coverage for claims against public companies are generally limited to so-called Securities Claims alleging a violation of any state, federal or foreign law regulating the purchase, sale or offer or solicitation of the purchase or sale of securities of the company.
For instance, in the case of FTX, the plaintiff alleged that he purchased an unregistered security from FTX in the form of a yield-bearing account (YBA) and funded the account with a sufficient amount of crypto-assets to earn interest on his holdings, in reliance of false and misleading representations by defendants. FTX’s former CEO, Sam Bankman-Fried (SBF), is named as a defendant in the lawsuit. If FTX purchased D&O insurance, SBF potentially would be covered with respect to any claims asserted against him in his official capacity as the CEO.
While D&O policies routinely exclude coverage for criminal or fraudulent acts or unlawful profit obtained by an insured’s wrongdoing, such exclusions may apply only in the event of a final, non-appealable adverse adjudication finding that the director or officer engaged in such acts. At a minimum, SBF likely would be entitled to advancement of his defense costs until such a finding occurred. In some instances, D&O policies also afford limited coverage for regulatory investigations of individual insureds. Thus, to the extent SBF is subpoenaed or otherwise called to testify or produce documents to the SEC, Department of Justice (DOJ) or other regulatory body, he might be covered in his capacity as a former officer of FTX.
Here, FTX is not named as a defendant in the subject class action, likely due to the automatic stay of suits filed against bankrupt debtors. However, if such stay were lifted by the bankruptcy court, FTX theoretically could seek coverage under a Management Liability Insurance (MLI) policy issued to privately held companies. Notably, MLI and other corporate liability insurance policies afford worldwide coverage. Thus, to the extent investors file legal proceedings against FTX or SBF outside of the United States, such claims may be covered. Moreover, the bankruptcy filing of the insured corporate debtor does not automatically extinguish the company’s rights under the policy.
Are Cryptocurrencies “Securities”?
With respect to D&O and Company liability insurance coverage, a key issue is whether the alleged wrongful acts occur in connection with the offer or sale of “securities.” In the case of FTX, plaintiffs allege that the YBAs were in fact unregistered securities subject to state or federal securities laws.
One hotly debated issue is whether cryptocurrencies, tokens and other digital assets constitute “securities” within the meaning of U.S. federal and state securities laws and otherwise subject to regulatory oversight and enforcement. For now, crypto markets in the United States are largely unregulated. Prior to the collapse of FTX, SBF was lobbying Congress to give primary oversight to the Commodities Futures Trading Commission (CFTC), which is considered by some in the industry to have a lighter touch than the SEC, which has more resources and has taken a more aggressive stance in pursuing enforcement actions against crypto firms. In the wake of the FTX collapse, there is an increased urgency for regulatory oversight of the crypto industry.
The battle between SEC and CFTC is now front and center. Recently, in remarks to the Senate, CFTC Chairman Rostin Behnam reiterated his support of proposed legislation that would give his agency oversight of trading in certain cryptocurrencies, including Bitcoin and Ether (ETH) in addition to other digital assets that could be classified as “commodities” within the purview of the CFTC. However, skeptics have questioned the cozy relationship between SBF and CFTC prior to the fall of FTX.
Meanwhile, earlier this year, the SEC announced that it had doubled the size of its dedicated Crypto Assets and Cyber Unit within the SEC’s Division of Enforcement. Since its creation in 2017, the SEC has brought 80 enforcement actions regulated to fraudulent and unregistered crypto asset offerings and platforms for violations of federal securities laws.
SEC Chairman Gary Gensler has been vocal in his position that most cryptocurrencies are securities under the Supreme Court’s Howey test, and the SEC should be the primary regulator for the crypto markets. According to Gensler, most crypto tokens are investment contracts under the Securities Act and under the Howey test because they involve (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits to be derived from the efforts of others. For instance, in prior enforcement actions, the SEC has taken the position that the offers and sales of tokens involve an investment of money – through USD, Bitcoin, ETH or other cryptocurrency – by investors.
These investors’ fortunes are tied to other investors in the same tokens, because if the value of the tokens increase, all investors share in that increased value on a pro rata basis. Furthermore, such investors reasonably expect to profit from their investments in the tokens based on managerial efforts and representations by the company. The SEC has found crypto firms and their management liable for violations of federal securities laws, regardless of whether such entities or crypto assets are formally registered with the SEC.
For now, even in the absence of crypto-specific legislation, crypto firms, exchanges and investors alike should assume that the SEC and other state and federal regulators will continue to rely on existing laws and regulations governing the financial markets to exercise oversight.
SEC Sues Sam Bankman-Fried
In yet another unexpected twist in the ongoing saga of FTX, on December 13, 2022, the SEC filed a Complaint against FTX co-founder and former CEO SBF in the U.S. District Court for the Southern District of New York for violations of federal securities laws.2
As noted by SEC Chairman Gary Gensler:
We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors it was one of the safest building in crypto.
The alleged fraud committed by Mr. Bankman-Fried is a clarion call to cypro platforms that they need to come into compliance with our [securities] laws… To those platforms that don’t comply with our securities law, the SEC’s Enforcement Division is ready to take action.3
As noted in the Complaint, SBF created a complex web of more than 100 entities centered on FTX and Alameda Research. FTX Trading Ltd. is a global crypto-asset trading platform that was formed as an Antigua and Barbuda limited corporation with its principal place of business in Hong Kong and the Bahamas. Alameda Research, LLC, a crypto trading firm specializing in crypto assets, is a Delaware company that had operations in the United States, Hong Kong and the Bahamas.
According to the SEC, SBF raised $1.8 billion from investors for various classes of FTX stock through multiple fundraising rounds, including $1.1 billion invested by 90 U.S. investors. The SEC alleges that SBF defrauded FTX equity investors by concealing the company’s deceptive business activities, including:
- Diverting FTX customer funds to Alameda
- Providing Alameda with an unlimited line of credit funded by FTX customer deposits
- Exempting Alameda from complying with FTX’s highly touted, sophisticated automated risk mitigation measures
- Tying FTX’s financial exposure to Alameda’s holdings of illiquid, over-valued assets, including FTT crypto tokens issued by FTX
- Using FTX customer funds to make undisclosed personal loans to SBF and other FTX executives.
Everything came to a head when FTX and its affiliates were forced to file for bankruptcy protection.
The SEC Complaint charges SBF with fraud in connection with the offer or sale of securities in violation of section 17(a) of the Securities Act of 1933 and section 10(b) of the Securities Exchange Act of 1934. By way of relief, the SEC seeks:
- Injunctive relief
- Disgorgement of ill-gotten gains
- Civil money penalties
- Imposition of a director and officer bar order
- Prohibition of SBF from participating in the offer or sale of securities.
Notably, the SEC’s claims against SBF stem from the sale of more than $1 billion of FTX stock to U.S. investors – including FTX Series A preferred stock, FTX Series B preferred stock, FTX Series B-1 stock and FTX Series C stock – in connection with a series of fundraising activities by FTX and SBF between August 2019 and January 2022. The SEC Complaint does not, however, specifically address the issue of whether cryptocurrency (such as the FTT tokens) or other digital assets held in custody, sold, traded or loaned by FTX or Alameda constitute “securities” within the meaning of U.S. securities laws. However, in other cases, the SEC has made it clear that it believes many cryptocurrencies and digital assets may be viewed as securities.
Moreover, the SEC has instituted enforcement actions against crypto firms and their principals regardless of whether such securities are registered with the SEC. Here, the SEC Complaint and prayer for relief does seek to enjoin SBF from ever engaging in the “issuance, purchase, offer, or sale of any securities, including crypto asset securities.” This underscores the SEC’s long-standing belief that the agency has regulatory oversight of crypto assets. While the FTX saga continues to unfold, it is clear that SBF and others will continue to face the wrath of regulators, Congress and prosecutors.
Interestingly, on the same day, the CFTC sued SBF, FTX and Alameda for violations of the Commodity Exchange Act (CEA).4 It is the position of the CFTC that certain digital assets and virtual currencies, including Bitcoin and ETH, are “commodities” as defined by the CEA.5 According to the CFTC, defendants’ now widely publicized activities “had a significant, observable negative impact on digital commodity markets.”6 In particular, defendants’ conduct caused a “significant negative price impact on the value of commodities in interstate commerce in the United States, including Bitcoin and Ether spot and futures prices.”7
These suits filed in tandem by the SEC and CFTC against SBF and FTX merely underscore the ongoing “tug of war” between and among regulators seeking to stake out their respective roles in oversight of the crypto market ecosystem. This highlights the need for greater clarity and laws specifically addressing the nuances and complexities of this new crypto world order.
For more information about this article or related topics involving cryptocurrency and digital assets, please contact Anjali C. Das, Partner and Co-Chair of Wilson Elser’s national Cybersecurity & Data Privacy Practice ([email protected]).
1 The coverage discussion set forth in this article is solely for illustrative purposes and is not intended to provide an official opinion with respect to any insurance coverage available to FTX, SBF or any other persons or entities.
2 SEC v. Samuel Bankman-Fried, Case No. 1:22-cv-10501 in the U.S. District Court for the Southern District of New York filed on December 13, 2022.
3 SEC Press Release 2022-219: “SEC Charges Samuel Bankman-Fried with Defrauding Investors in Crypto Assets Trading Platform FTX,” December 13, 2022.
4 CFTC v. Samuel Bankman-Fried, et al., Case No. 1:22-cv-10503 in the U.S. District Court for the Southern District of New York filed December 13, 2022.
5 Id., Complaint, par. 21.
6 Id., Complaint, par. 112.
7 Id., Complaint, par. 114.
Wotton + Kearney has been recognised as a Band 1 insurance law firm in Australia and New Zealand in the 2023 Chambers Asia-Pacific legal rankings released today. This is the 11th year in a row the firm has been recognised as a Band 1 firm in Australia. Fifteen of the firm’s senior lawyers were also recognised, including 3 for the Shipping category.
Congratulations to our listed lawyers Adam Chylek, Andrew Moore, Belinda Henningham, Cain Jackson, David Kearney and Naraya Lamart in Australia, and to Antony Holden, Andrew Moore, Caroline Laband, Jeanette Hayes, Mathew Francis, Misha Henaghan, Neil Beadle, Peter Leman and Sophie Lucas in New Zealand.
Australia Insurance: https://lnkd.in/gNvpmeXS
New Zealand Insurance: https://lnkd.in/guJ4pUAr
Best Lawyers® and U.S. News & World Report, for the thirteenth consecutive year, collaboratively announced their “Best Law Firms” rankings.
Wilson Elser’s National Insurance Law Practice is again ranked Tier One, joined this year by Railroad Law. National Tier 2 rankings include Admiralty & Maritime Law and Mass Tort Litigation / Class Actions – Defendants; followed by National Tier 3 rankings in Commercial Litigation, Corporate Law and Mergers & Acquisitions Law. Seventeen of the firm’s offices received Metropolitan Tier 1, 2 and 3 rankings across a variety of practice areas.
Earlier this year, U.S. News & World Report and Best Lawyers® ranked 69 Wilson Elser attorneys representing 24 offices among the 2023 Best Lawyers in America, and named four attorneys “Lawyer of the Year.” Also named were 81 Wilson Elser attorneys included on the 2023 “Ones to Watch” list.
National Tier 1
- Insurance Law
- Railroad Law
National Tier 2
- Admiralty & Maritime Law
- Mass Tort Litigation / Class Actions – Defendants
National Tier 3
- Commercial Litigation
- Corporate Law
- Mergers & Acquisitions Law
Metropolitan Tier 1
- Houston: Railroad Law
- Jackson, MS: Litigation – Tax
- Louisville: Medical Malpractice Law – Defendants
- New Jersey*: Banking and Finance Law; Insurance Law; Legal Malpractice Law – Defendants; Litigation – Insurance; Product Liability Litigation – Defendants
- New Orleans: Admiralty & Maritime Law
- San Diego: Medical Malpractice Law – Defendants; Professional Malpractice Law – Defendants
- Washington, D.C.: Medical Malpractice Law – Defendants
Metropolitan Tier 2
- Baltimore: Product Liability Litigation – Defendants; Professional Malpractice Law – Defendants
- Birmingham: Litigation – Environmental; Mass Tort Litigation / Class Actions; Personal Injury Litigation – Defendants; Transportation Law
- Boston: Personal Injury Litigation – Defendants
- Houston: Admiralty & Maritime Law; Commercial Litigation; Mass Tort Litigation / Class Actions; Medical Malpractice Law – Defendants; Product Liability Litigation – Defendants
- Jackson-MS: Mass Tort Litigation / Class Actions; Personal Injury Litigation – Defendants; Product Liability Litigation – Defendants
- Los Angeles: Corporate Compliance Law; Corporate Governance Law; Insurance Law; Mergers & Acquisitions Law
- Louisville: Litigation – Health Care; Litigation – Insurance
- New Jersey*: Commercial Litigation; Corporate Law; Trust & Estates Law
- San Francisco: Product Liability Litigation – Defendants
- Stamford: Product Liability Litigation – Defendants
- Washington, D.C.: Personal Injury Litigation – Defendants
Metropolitan Tier 3
- Albany: Product Liability Litigation – Defendants
- Birmingham: Product Liability Litigation – Defendants
- Boston: Insurance Law
- Chicago: Commercial Litigation
- Colorado: Litigation – Insurance
- Dallas/Fort Worth: Personal Injury Litigation – Defendants
- Houston: Personal Injury Litigation – Defendants
- Los Angeles: Commercial Litigation
- Louisville: Personal Injury Litigation – Defendants
- New Jersey*: Professional Malpractice Law – Defendants
- New Orleans: Commercial Litigation
- New York City: Insurance Law; Medical Malpractice Law – Defendants
- Stamford: Insurance Law
* Included in a list called Super Lawyers® selected by independent research and peer nominations and evaluations, 2014–2023. No aspect of this selection is approved by the New Jersey Supreme Court.
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