Category: finance

Crypto Laundering: Bitcoin + Money Laundering

Bitcoin was a massive innovation to the world that allows transactions to be processed faster, makes them easier to use, lack third parties and intermediaries, and have stronger security. The technology underlying Bitcoin is the blockchain, which is the decentralized ledger where all Bitcoin transactions are stored.

At the same time, criminals are increasingly seeking to exploit the latest technology to their financial benefit. Bitcoin transactions actually have the ability to make money laundering easier for criminals because cryptocurrencies are conducted, transferred, and stored online and allow cybercriminals to move their funds instantly across borders.

This article explains the interconnection between Bitcoin and money laundering, warning signs, and how a lawyer can help you with your crypto issue.

Bitcoin as an Attractive Option for Laundering

One of the first questions many ask is why is Bitcoin such an attractive option for criminals seeking to launder money?

The most important answer is that laundering cryptocurrencies via online exchanges and then converting them to cash is much simpler than laundering bags of cash often across borders. Online transactions have no borders, and it obviates the need to physically move illegal money from place to place. Therefore, it is easy and practical.

Second, there is a certain degree of anonymity associated with Bitcoin transactions. While not 100% anonymous, these transactions are in fact pseudonymous. This means that the public Bitcoin addresses used for transactions are not registered in the names of individuals.

The transactions are stored publicly on the blockchain (the public decentralized ledger where all transactions are stored), but only the individual making the transaction has access to the account and Bitcoin wallet. Therefore, federal agencies will have a challenging time linking a particular Bitcoin transaction back to any one individual or entity. However, detection is not impossible.

To overcome this obstacle, criminals will use Bitcoin mixing services, which allow the individual to “mix” their Bitcoins with other users and jumble the connections between individuals’ addresses.

The goal is to make it practically impossible for anyone to detect the origin and destination addresses of those illegal Bitcoin transactions. This allows criminals to cash out without fear of ever being identified. In addition, many wallet providers and online crypto exchanges have few if not no anti-money laundering (“AML”) or Know Your Customer (“KYC”) regulations, which represents a very attractive option for cybercriminals.

Third, the lack of regulation or inconsistent regulation of the crypto sphere makes detection of large Bitcoin transactions more unlikely—both the initial Bitcoin transaction and when the criminals seek to “cash-out” and convert their Bitcoins to cash.

Traditional financial and banking options are very regulated both at the state and federal levels. On the other hand, cryptocurrencies are loosely regulated. This makes the use of cryptocurrencies attractive to criminals who believe they can evade regulation and scrutiny of various law enforcement agencies within the nation and abroad.

Warning Signs of Crypto Laundering

Crypto laundering is a crime. Despite the lack of federal guidance on this issue, many law enforcement agencies are relying on existing laws and traditional investigative tools to uncover instances of crypto laundering. Below are some warning signs of crypto laundering:

  • Transfer of crypto funds to wallets in unregulated or less regulated jurisdictions;
  • Multiple high-value transactions occurring within a short period of time;
  • Bitcoin or other transactions totaling amounts that are just under the amount that would trigger reporting requirements;
  • Immediately withdrawing cryptocurrency deposits;
  • New accounts funded with an amount that is immediately withdrawn;
  • Transactions with multiple cryptocurrencies on many accounts;
  • Deposits from unregulated jurisdictions or jurisdictions with poor AML and KYC regulations; and
  • One wallet that is linked to multiple credit card accounts under different individuals’ names or one wallet linked to multiple bank accounts.

The above warning signs should be considered by individuals seeking to do business with a firm dealing with cryptocurrencies, by law enforcement agencies investigating certain individuals and entities, and during AML reviews within crypto service providers.

In addition, in 2020, the Financial Action Task Force (“FATF”) released a report about red flag indicators for money laundering that is intended to assist crypto wallet and exchange companies as well as financial authorities.

How An Attorney Can Help Defend You Against Crypto Laundering Allegations

Federal agencies including the Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”) have been especially eager to investigate alleged instances of crypto laundering fraud. On June 29, 2021, in a DOJ investigation, “Doctor Bitcoin ” pleaded guilty to operating an illegal cash-to-cryptocurrency conversion business. This underscores the importance of retaining counsel experienced in defending against allegations of crypto laundering. Below are some examples of how an attorney can help you with your crypto issue:

  • Conducting fraud investigations involving cryptocurrencies;
  • Advising on Security Token Offerings (“STOs”) and Initial Coin Offerings (“ICOs”);
  • Valuing of cryptocurrencies and assets;
  • Assisting with purchasing property or other assets with cryptos;
  • Advising on AML and KYC regulations;
  • Checking on internal and external compliance;
  • Advising on wills, trusts, and inheritances of crypto assets and cryptocurrencies;
  • Drafting compliance documents or documents regarding coin issuances;
  • Advising on due diligence of customers;
  • Advising on identification and verification procedures involving crypto transactions; and
  • Advising on monitoring crypto transactions for compliance with applicable regulations, for suspicious activity, and for certain money laundering warning signs.

“The use of cryptocurrencies such as Bitcoin to facilitate online transactions has both advantages and disadvantages. While crypto transactions offer speed, ease in use, and low transaction costs, they can also facilitate elaborate money laundering schemes, illegal purchases, and ransomware attacks. Specifically, Bitcoin laundering is becoming a cost-effective and highly appealing option for cyber criminals aiming to convert illegally obtained cryptocurrencies into legitimate cash. While there are few laws regulating cryptocurrencies, many federal agencies will go after companies and individuals alleged to have engaged in fraudulent crypto transactions under already-existing statutes. Therefore, the consequences can be just as severe—fines and penalties, disgorgement orders, injunctions, and possibly jail time.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

Conclusion

Crypto laundering is becoming a serious problem for law enforcement agencies as cybercriminals continue to exploit new and emerging technologies for financial gain. Criminals are attracted to the cryptocurrency, Bitcoin, because it is easy and practical to move digitized money, because these transactions are very difficult to trace, and because there is a lack of consistent regulation regarding cryptocurrencies.

Identifying red flags are important safeguards for individuals, businesses, and law enforcement agencies to consider. In fact, law enforcement agencies have been especially zealous in investigating alleged instances of crypto laundering based on certain red flags.

This article was written by Dr. Nick Oberheiden of Oberheiden PC. For more articles relating to crypto laundering, please visit our finance page.

A Flurry of CFTC Actions Shock the Cryptocurrency Industry

The Commodity Futures Trading Commission (CFTC) sent shockwaves across the cryptocurrency industry when it issued a $1.25 million settlement order with Kraken, one of the industry’s largest market participants. The next day, the CFTC announced that it had charged each of 14 entities for offering cryptocurrency derivatives and margin trading without registering as a futures commission merchant (FCM). While the CFTC has issued regulatory guidance in the past and engaged in some regulatory enforcement activities, it has now established itself as a key regulator of the industry along with the US Securities and Exchange Commission (SEC), the US Department of Justice (DOJ) and the US Department of the Treasury (Treasury). Market participants should be aware that the CFTC will continue to take a more active role in regulation and enforcement of commodities and derivatives transactions moving forward.

The CFTC alleged that each of the defendants were acting as an unregistered FCM. Under Section 1a(28)(a) of the Commodity Exchange Act (the Act), 7 U.S.C. § 1(a)(28)(A), an FCM is any “individual, association, partnership, or trust that is engaged in soliciting or accepting orders for the purchase or sale of a commodity for future delivery; a security futures product; a swap . . . any commodity option authorized under section 6c of this title; or any leverage transaction authorized under section 23 of this title.” In order to be considered an FCM, that entity must also “accept[] money, securities, or property (or extends credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result or may result therefrom.” (See: 7 U.S.C. § 1(a)(28)(A)(II).) 7 U.S.C. § 6d(1), requires FCMs to be registered with the CFTC.

IN DEPTH

THE KRAKEN SETTLEMENT

On September 28, 2021, the CFTC issued an order, filing and settling charges against respondent Payward Ventures, Inc. d/b/a Kraken for offering margined retail commodity transactions in cryptocurrency—including Bitcoin—and failing to register as an FCM. Kraken is required to pay a $1.25 million civil monetary penalty and to cease and desist from further violations of the Act. The CFTC stated that, “This action is part of the CFTC’s broader effort to protect U.S. customers.”

The CFTC’s order finds that from approximately June 2020 to July 2021, Kraken violated Section 4(a) of the Act, 7 U.S.C. § 6(a)(2018) by offering to enter into, entering into, executing and/or confirming the execution of off-exchange retail commodity transactions with US customers who were not eligible contract participants or eligible commercial entities. The CFTC also found that Kraken operated as an unregistered FCM in violation of Section 4d(a)(1) of the Act, 7 U.S.C. § 6d(a)(1) (2018). According to the order, Kraken served as the sole margin provider and maintained physical and/or constructive custody of all assets purchased using margins for the duration of a customer’s open margined position.

Margined transactions worked as follows: The customer opened an individual account at Kraken and deposited cryptocurrency or fiat currency into the account. The customer then initiated a trade by selecting (1) the trading pair they wished to trade, (2) a purchase or sale transaction and (3) a margin option. All trades were placed on Kraken’s central limit order book and executed individually for each customer. If a customer purchased an asset using margin, Kraken supplied the cryptocurrency or national currency to pay the seller for the asset. If a customer sold an asset using margin, Kraken supplied the cryptocurrency or national currency due to the buyer. Trading on margin allowed the customer to establish a position but also created an obligation for the customer to repay Kraken at the time the margined position was closed. The customer’s position remained open until they submitted a closing trade, they repaid the margin or Kraken initiated a forced liquidation based on the occurrence of certain triggering events, including limitations on the duration of an open margin position and pre-set margin thresholds. Kraken required customers to exit their positions and repay the assets received to trade on margin within 28 days, however, customers could not transfer assets away from Kraken until satisfying their repayment obligation. If repayment was not made within 28 days, Kraken could unilaterally force the margin position to be liquidated or could also initiate a forced liquidation if the value of the collateral dipped below a certain threshold percentage of the total outstanding margin. As a result, actual delivery of the purchased assets failed to occur.

The CFTC asserted that these transactions were unlawful because they were required to take place on a designated contract market. Additionally, by soliciting and accepting orders for, and entering into, retail commodity transactions with customers and accepting money or property (or extending credit in lieu thereof) to margin these transactions, Kraken was operating as an unregistered FCM.

Coinciding with the release of the enforcement action against Kraken, CFTC Commissioner Dawn D. Sump issued a “concurring statement.” In it, she appeared to be calling upon the CFTC to adopt more specific rules governing the products that are the subject of the enforcement action. Commissioner Sump seemed to indicate that it would be helpful to cryptocurrency market participants if the CFTC clarified its position on the applicability of the Act, as well as registration requirements. The CFTC will likely issue guidance or rules to clarify its position on which cryptocurrency-related products trigger registration requirements.

CFTC CHARGES 14 CRYPTOCURRENCY ENTITIES

On September 29, 2021, the CFTC issued a press release and 14 complaints against cryptocurrency trading platforms. The CFTC is seeking a sanction “directing [the cryptocurrency platforms] to cease and desist from violating the provisions of the Act set forth herein.” Each of the platforms have 20 days to respond.

All of the complaints are somewhat similar in that the CFTC alleges that each of the cryptocurrency platforms “from at least May 2021 and through the present” have offered services to the public “including soliciting or accepting orders for binary options that are based off the value of a variety of assets including commodities such as foreign currencies and cryptocurrencies including Bitcoin, and accepting and holding customer money in connection with those purchases of binary options.”

The CFTC has taken the position that “binary options that are based on the price of an underlying commodity like forex or cryptocurrency are swaps and commodity options as used in the definition of an FCM.” (The CFTC has previously taken the position that Bitcoin and Ethereum constitute “commodities,” doing so in public statements and enforcement actions.) In a prominent enforcement action previously filed by the CFTC in the United States District Court for the Eastern District of New York, the court held that “virtual currency may be regulated by the CFTC as a commodity” and that it “falls well-within the common definition of ‘commodity’ as well as the CEA’s definition of commodities.” (See: CFTC v. McDonnell, et al., 287 F. Supp. 3d 213, 228 (E.D.N.Y. Mar. 6, 2018); CFTC v. McDonnell, et al., No. 18-cv-461, ECF No. 172 (E.D.N.Y. Aug. 23, 2018).) In the action the CFTC filed against BitMEX in October of 2020, it alleged that “digital assets, such as bitcoin, ether, and litecoin are ‘commodities’ as defined under Section 1a(9) of the Act, 7 U.S.C. § 1a(9). (See: CFTC v. HDR Global Trading Limited, et al., No. 20-cv-8132, ECF 1, ¶ 23 (S.D.N.Y. Oct. 1, 2020).)

The CFTC has previously taken the position that Bitcoin, Ethereum and Litecoin are considered commodities. However, in these recently filed complaints, the CFTC did not appear to limit the cryptocurrencies that would be considered “commodities” to just Bitcoin, Ethereum and Litecoin. Instead, the CFTC broadly referred to “commodities such as foreign currencies and cryptocurrencies including Bitcoin.” It remains to be seen which of the hundreds of cryptocurrencies on the market will be considered “commodities,” but it appears that the CFTC is not limiting its jurisdiction to just three. It is also an open question as to whether there are certain cryptocurrencies or cryptocurrency referencing financial products that the SEC and CFTC will determine are subject to the overlapping jurisdiction of both regulators, similar to mixed swaps under the derivatives rules.

The CFTC also singled out two of these cryptocurrency platforms, alleging that they issued false statements to the effect that it “is a registered FCM and RFED with the CFTC and member of the NFA.” The CFTC noted that neither of these entities were ever registered with the National Futures Association (NFA) and one of the NFA ID numbers listed “identifies an individual who was once registered with the CFTC but has been deceased since 2009.”

WHAT’S NEXT

While the SEC, Treasury and DOJ are often considered the most prominent federal regulators in the cryptocurrency space, this recent sweep by the CFTC is not the first time it has flexed its muscles. The CFTC went to trial and won in 2018, accusing an individual of operating a boiler room. In October 2020, the CFTC filed a case against popular cryptocurrency exchange BitMEX for failing to register as an FCM, among other counts. However, unlike those one-off enforcement actions, the recent actions targeting multiple market participants within two days is a big step forward for the CFTC. Cryptocurrency derivative trading has been rising in popularity over the last few years and it is unsurprising that the CFTC is taking a more active enforcement role.

It is expected that regulatory activity within the cryptocurrency space will increase from all US regulators, including the CFTC, SEC, Treasury and the Office of the Comptroller of the Currency, especially as cryptocurrency products are increasingly classified as financial products subject to regulation. While the CFTC and other regulators have issued some regulatory guidance, regulators appear to be taking a “regulatory guidance by enforcement action” strategy. Market participants will need to thoughtfully consider all relevant regulatory regimes in order to determine what compliance activities are necessary. As we describe, multiple classifications are possible.

© 2021 McDermott Will & Emery
For more on cryptocurrency litigation, visit the NLR Cybersecurity, Media & FCC section.

Agencies and Regulators Focus on AML Compliance for Cryptocurrency Industry

This year, regulators, supported by a slate of new legislation, have focused more of their efforts on AML violations and compliance deficiencies than ever before. As we have written about in the “AML Enforcement Continues to Trend in 2021” advisory, money laundering provisions in the National Defense Authorization Act for fiscal year 2021 (the NDAA) expanded the number of businesses required to report suspicious transactions, provided new tools to law enforcement to subpoena foreign banks, expanded the AML whistleblower program, and increased fines and penalties for companies who violate anti-money laundering provisions. The NDAA, consistent with Treasury regulations, also categorized cryptocurrencies as the same as fiat currencies for purposes of AML compliance.

In addition, as discussed in the “Businesses Must Prepare for Expansive AML Reporting of Beneficial Ownership Interests” advisory, the NDAA imposed new obligations on corporations, limited liability companies, and similar entities to report beneficial ownership information. Although the extent of that reporting has not yet been defined, the notice of proposed rulemaking issued by FinCEN raises serious concerns that the Treasury Department may require businesses to report beneficial ownership information for corporate affiliates, parents and subsidiaries; as well as to detail the entity’s relationship to the beneficial owner. Shortly after passage of the NDAA, Treasury Secretary Janet Yellen stressed that the Act “couldn’t have come at a better time,” and pledged to prioritize its implementation.

Money laundering in the cryptocurrency space has attracted increased attention from regulators and the IRS may soon have an additional tool at its disposal if H.R. 3684 (the bipartisan infrastructure bill) is signed into law. That bill includes AML provisions that would require stringent reporting of cryptocurrency transactions by brokers. If enacted, the IRS will be able to use these reports to identify large transfers of cryptocurrency assets, conduct money laundering investigations, and secure additional taxable income. Who qualifies as a “broker,” however, is still up for debate but some fear the term may be interpreted to encompass cryptocurrency miners, wallet providers and other software developers. According to some cryptocurrency experts, such an expansive reporting regime would prove unworkable for the industry. In response, an anonymous source from the Treasury Department told Bloomberg News that Treasury was already working on guidance to limit the scope of the term.

In addition to these legislative developments, regulators are already staking their claims over jurisdiction to conduct AML investigations in the cryptocurrency area. This month, SEC Chair Gary Gensler, in arguing that the SEC had broad authority over cryptocurrency, claimed that cryptocurrency was being used to “skirt our laws,” and likened the cryptocurrency space to “the Wild West . . . rife with fraud, scams, and abuse” — a sweeping allegation that received much backlash from not only cryptocurrency groups, but other regulators as well. CFTC Commissioner Brian Quintez, for example, tweeted in response: “Just so we’re all clear here, the SEC has no authority over pure commodities . . . [including] crypto assets.” Despite this disagreement, both regulatory agencies have collected millions of dollars in penalties from companies alleged to have violated AML laws or BSA reporting requirements. Just last week, a cryptocurrency exchange reached a $100 million settlement with FinCEN and the CFTC, stemming from allegations that the exchange did not conduct adequate due diligence and failed to report suspicious transactions.

With so many governmental entities focused on combatting money laundering, companies in the cryptocurrency space must stay abreast of these fast-moving developments. The combination of increased reporting obligations, additional law enforcement tools, and heightened penalties make it essential for cryptocurrency firms to institute strong compliance programs, update their AML manuals and policies, conduct regular self-assessments, and adequately train their employees. Companies should also expect additional regulations to be issued and new legislation to be enacted in the coming year. Stay tuned.

©2021 Katten Muchin Rosenman LLP

How to Report Spoofing and Earn an SEC Whistleblower Award

Spoofing is a form of market manipulation where traders artificially inflate the supply and demand of an asset to increase profits. Traders engaged in spoofing place a large number of orders to buy or sell a certain stock or asset without the intent to follow through on the orders. This deceptive trading practice leads other market participants to wrongly believe that there is pressure to act on that asset and “spoofs” other participants to place orders at artificially altered prices.

Spoofing affects prices because the artificial increase in activity on either the buy or sell side of an asset creates the perception that there is a shift in the number of investors wanting to buy or sell. Spoofers place false bids or offers with the intent to cancel before executing so that they can then follow-through on genuine orders at a more favorable price. Often, spoofers use automated trading and algorithms to achieve their goals.

The Dodd-Frank Act of 2010 prohibits spoofing, which it defines as “bidding or offering with the intent to cancel the bid or offer before execution.” 7 U.S.C. § 6c(a)(5)(C). Spoofing also violates SEC rules, including the market manipulation provisions of Section 9(a)(2) of the Securities Exchange Act of 1934.

Spoofing Enforcement Actions  

In the Matter of J.P. Morgan Securities LLC

On September 29, 2020, the U.S. Securities and Exchange Commission (“SEC”) announced charges against J.P. Morgan Securities LLC, a broker-dealer subsidiary of JPMorgan Chase & Co., for fraudulently engaging in manipulative trading of U.S. Treasury securities. According to the SEC’s order, certain traders on J.P. Morgan Securities’ Treasuries trading desk placed genuine orders to buy or sell a particular Treasury security, while nearly simultaneously placing spoofing orders, which the traders did not intend to execute, for the same series of Treasury security on the opposite side of the market. The spoofing orders were intended to create a false appearance of buy or sell interest, which would induce other market participants to trade against the genuine orders at prices that were more favorable to J.P. Morgan Securities than J.P. Morgan Securities otherwise would have been able to obtain.

JPMorgan Chase & Co. agreed to pay disgorgement of $10 million and a civil penalty of $25 million to settle the SEC’s action. In addition, the U.S. Department of Justice (“DOJ”) and the U.S. Commodity Futures Trading Commission (“CFTC”) brought parallel actions against JPMorgan Chase & Co. and certain of its affiliates for engaging in the manipulative trading. In total, the three actions resulted in monetary sanctions against JPMorgan Chase & Co. totaling $920 million, which included amounts for criminal restitution, forfeiture, disgorgement, penalties, and fines.

United States of America v. Edward Bases and John Pacilio

On August 5, 2021, a federal jury convicted Edward Bases and John Pacilio, two former Merrill Lynch traders, for engaging in a multi-year fraud scheme to manipulate the precious metals market. According to the U.S. Department of Justice’s (“DOJ”) press release announcing the action, the two traders fraudulently pushed market prices up or down by routinely placing large “spoof” orders in the precious metals futures markets that they did not intend to fill.

After manipulating the market, Bases and Pacilio executed trades at favorable prices for their own gain, and to the detriment of other traders. The DOJ’s Indictment detailed how Bases and Pacilio discussed their intent to “push” the market through spoofing in electronic chat conversations.

In the Matter of Nicholas Mejia Scrivener

The SEC recently charged a California day trader with spoofing, where he placed multiple orders to buy or sell a stock, sometimes at multiple price levels that he did not intend to execute. The SEC alleged that the purpose of the false orders was to create the appearance of inflated market interest and induce other actors to trade at artificial prices. The trader then completed genuine orders at manipulated prices and withdrew the false orders. The SEC found that the trader’s conduct violated Section 9(a)(2) of the Exchange Act of 1934, and the trader settled by consenting to a cease-and-desist order and paying in disgorgement, in interest, and a civil penalty.

SEC and CFTC Whistleblower Awards for Reporting Spoofing

Under the SEC Whistleblower Program and CFTC Whistleblower Program, a whistleblower who reports spoofing to the SEC or CFTC may be eligible for an award. These practices may constitute spoofing:

  • Placing buy or sell orders for a stock or asset without the intent to execute;
  • Attempting to entice other traders to act on a certain stock or asset to manipulate market prices and profitability;
  • Creating a false appearance of market interest to manipulate the price of a stock or asset;
  • Placing deceptively large buy or sell orders only to withdraw those orders once smaller, genuine orders on the other side of the market have been filled;
  • Using false orders to favorably affect prices of a stock or asset (to increase market prices if intending to sell or to decrease market prices if intending to buy) so that one can then receive more ideal prices for a genuine order.

If a whistleblower’s information leads the SEC or CFTC to a successful enforcement action with total monetary sanctions in excess of $1 million, a whistleblower may receive an award of between 10 and 30 percent of the total monetary sanctions collected.

Since 2012, the SEC has issued nearly $1 billion to whistleblowers and the CFTC has issued approximately $123 million to whistleblowers. The largest SEC whistleblower awards to date are $114 million and $50 million. The largest CFTC whistleblower awards to date are $45 million and $30 million.

How to Report Spoofing and Earn a Whistleblower Award

To report spoofing and qualify for a whistleblower award, the SEC and CFTC require whistleblowers or their attorneys report their tips online through their Tip, Complaint or Referral Portals or mail/fax Form TCRs to the whistleblower offices. Prior to submitting a tip, whistleblowers should consider scheduling a confidential consultation with a whistleblower attorney.

The path to receiving an award is lengthy and complex. Experienced whistleblower attorneys can provide critical guidance to whistleblowers throughout this process to increase the likelihood that they not only obtain, but maximize, their awards.

SEC and CFTC Whistleblower Protections for Disclosures About Spoofing

The SEC and CFTC Whistleblower Programs protect the confidentiality of whistleblowers and do not disclose information that might directly or indirectly reveal a whistleblower’s identity. Moreover, a whistleblower can submit an anonymous tip to the SEC and CFTC if represented by counsel. In certain circumstances, a whistleblower may remain anonymous, even to the SEC and CFTC, until an award determination. However, even at the time of an award, a whistleblower’s identity is not made available to the public.

© 2021 Zuckerman Law

Article by Jason Zuckerman, Matthew Stock, and Katherine Krems with Zuckerman Law.

For more articles on the SEC and whistleblower awards, follow the NLR Financial Securities & Banking section.

Huge Win for Private Student Loan Borrowers

Student loans are notoriously difficult to shed through the bankruptcy process.  A person must show that it would impose an “undue hardship” on them to be required to repay the student loans, and the test for proving undue hardship has historically been nearly insurmountable.

The Second Circuit Court of Appeals has handed a game-changer ruling to people in New York, Connecticut and Vermont who are suffocating under the weight of private student loan debt.  In a major blow to many private lenders, the Second Circuit ruled that a private student loan is NOT an “obligation to repay funds received as an educational benefit”—as Navient (one of the largest private student loan servicers) has long argued—and therefore IS dischargeable in bankruptcy without having to prove undue hardship.  This quoted language may sound like it applies to private loans, but the Second Circuit found that it really refers to conditional grants that are similar to scholarships and stipends—not loans.

While this ruling does NOT apply to government funded or backed loans, it is going to help a large number of people discharge huge amounts of private student loan debt through bankruptcy. It will be interesting to see how many other circuits follow this approach, and whether it gives bankruptcy judges throughout the country—many of whom have commented in written opinions on the harshness of the “undue hardship” tests—persuasive authority on which to base decisions discharging private student loan debt.

The Second Circuit’s unanimous and well-reasoned decision (the language of which is fairly damning on Navient) can be viewed here.  And if you’re curious whether your student loan is private, see if you can find it here (if not, it’s a private loan).

©2021 Roetzel & Andress
For more articles on student loans, visit the NLRFinancial Institutions & Banking section.

Their Aim Wasn’t True – The NRA and Bad Faith Bankruptcy Filings

Bankruptcy offers a temporary sanctuary for parties seeking relief from a variety of problems – financial crisis, lawsuits, collection actions, repossessions, foreclosure, and pandemics.

Filing bankruptcy before a money judgment is entered or on the eve of a foreclosure sale is – often to the consternation of creditors – perfectly valid.  Creditors often complain that the debtor is acting in bad faith, and the bankruptcy court should toss the case.  Those arguments almost always fail.

But not all bankruptcy cases survive long enough for a debtor to reorganize.  When a case is truly filed in “bad faith,” the bankruptcy court can and often will dismiss it.  So when a Bankruptcy Court in Texas recently dismissed the Chapter 11 case filed by the National Rifle Association, it provided an opportunity to look at what constitutes a bad faith filing under the Bankruptcy Code.

The NRA was sued by the New York Attorney General, who alleged the NRA had committed a variety of illegal acts in violation of New York’s laws governing not-for-profits.  The New York Attorney General has the power to bring enforcement actions against charities like the NRA and, if successful, one of the potential remedies is the dissolution of the charity.  The NRA sought to avoid the enforcement action – and particularly the specter of dissolution – by filing bankruptcy and moving to Texas.

When a party files a bankruptcy petition, it must do so for a valid bankruptcy purpose; otherwise, it is a bad faith filing.  Valid bankruptcy purposes include avoiding foreclosure, avoiding having to shutter operations, reducing operating costs, addressing burdensome contracts and leases, streamlining and consolidating litigation, attempting to preserve a business as a going concern, or simply obtaining a breathing spell to deal with creditors.  A petition filed merely to obtain a tactical litigation advantage is a bad faith filing.

To determine good faith versus bad faith, the courts must consider the totality of the circumstances based on the debtor’s financial condition, motives, and the local financial realities.  No single factor is dispositive.  Since the court must evaluate and decide the issue, witness testimony – particularly from the parties who decided to file the case – is a critical factor.  The burden is on the party seeking dismissal to prove bad faith by the debtor.  If that party can muster enough evidence to suggest bad faith, then the burden shifts to the debtor to prove that it was acting in good faith.

After a 12-day trial with 23 witnesses, the Bankruptcy Court found that the NRA’s bankruptcy petition was not filed in good faith based on the totality of the circumstances. The NRA was not in financial distress and had funds to pay all their creditors in full.   The NRA filed their petition to gain an unfair litigation advantage in the New York Attorney General enforcement action.  New York might still be able to get a money judgment, but the NRA wanted to take dissolution off the table.  The enforcement action was different than a lawsuit by a disgruntled vendor.  It was to enforce New York’s regulatory scheme for charities, and the NRA was using bankruptcy to try to avoid that regulatory scheme.  This was not a legitimate bankruptcy purpose.

The lesson for creditors is that, although infrequent, there are circumstances when a bankruptcy court will dismiss a case.  If the debtor has filed a case for a patently improper purpose, you may get it dismissed.  But to pursue dismissal and succeed, you need to be prepared to go to trial and present compelling evidence of bad faith to the court through documents and witness testimony.

© 2021 Ward and Smith, P.A.. All Rights Reserved.
For more articles on bankruptcy, visit the NLR Bankruptcy & Restructuring section.

Lending Options for Law Firms Even More Relevant During a Crisis: A Q&A with Esquire Bank’s Ari Kornhaber

Plaintiffs’ law firms take cases on a contingency basis and frequently face defendants with deep pockets who can afford to wait their cases out. The COVID-19 crisis has added even more uncertainty to the litigation process and cash flow for law firms.

Large amounts, often in the hundreds of thousands of dollars can come due for plaintiffs’ law firms incurring expenses during drawn-out cases, especially for cases with multiple plaintiffs and cases where expert testimony is required.

For contingency cases, the large sums of law firm capital that are tied up in case costs for many years can limit law firms’ ability to utilize that capital for business expansion or to invest in other fee-generating cases.

Unlike traditional businesses, law firms cannot simply raise capital for operating expenses. Current legal ethics rules prohibit non-attorneys from taking ownership interests in law firms, which eliminates the use of securities as a funding option and while attorneys can borrow funds, it often must be from a non-traditional lender because a potential litigation victory generally falls outside the scope of what is considered acceptable collateral.

This often leads law firm management to pursue alternative lending options from non-traditional lenders like litigation financers or specialty lenders, who emphasize their core differentiator is that they can use a law firm’s case inventory as collateral – however, this often comes with a less-competitive interest rate than traditional banks.

Ari Kornhaber, Esq., Founder, Executive Vice President and Head of Corporate Development at Esquire Bank provides insight on financing options for plaintiffs’ firms and how to ensure your law firm approaches it the right way.

NLR: How have you seen contingency fee law firms maintain their businesses throughout the pandemic?

Kornhaber: The pandemic has forced many trial lawyers to take an honest look at themselves and often rethink their business models. Decisions that made sense pre-pandemic may not make sense now, especially in today’s low-interest-rate environment. As a result, contingency fee law firms are examining whether their current approach to law firm capitalization makes sense. Many lawyers that I speak to are taking a more proactive approach to how they run their business.

NLR: As we emerge from the pandemic, what are plaintiff’s firms worrying about most?

Kornhaber: Now more than ever, lawyers who run contingency fee law firms are concerned about the future. There is a general feeling out there that their businesses haven’t fully felt the effects of the pandemic yet, due to the nature of the business. Cases that are signed up today won’t generate revenue for months or years. The decline in intakes months ago, won’t truly be felt for months, a year, or more. This has self-financed law firms particularly concerned, as their nature is to be debt-adverse. For these self-financed firms, the combination of intakes being down and cases taking longer to settle means they will have to dig deeper into their own pockets. Meanwhile, other law firms with access to capital are using this time to move their businesses forward by investing in new legal technology, infrastructure, and talent.

NLR: What are some key takeaways self-financed law firms should know about their borrowing options?

Kornhaber: The current economy has created a low-interest-rate environment. Going to your bank and asking them what they can do for you is the first thing self-financed firms should do. It is important to note that banks covet law firms as customers because they come with low-cost deposits. Also, trial law is an industry that is classified as ‘recession proof’. Banks and lenders are trying to put their best foot forward for new law firm clients – so there is no better time than right now to speak to a bank to see how they can help.

The catch, however, with speaking to a traditional bank is that they rarely use the value of your case inventory as collateral for lending purposes. This means they will look at your previous financial performance to come up with how much they can lend you – ignoring the revenue your law firm will generate via the cases that are in your inventory today and tomorrow. The final amount of credit offered is often not enough for many lawyers.

NLR: What about specialty litigation finance companies?

Kornhaber: Specialty finance companies play an important role in the equation, as they can often lend to law firms that the traditional banks often ignore. Specialty legal finance companies are more likely to take on these ‘riskier’ clients, but usually at much higher interest rates and fees as compared to banks to compensate for the additional risk.

Higher risk law firm clients frequently have exhausted their options with the ‘mega banks’ and are struggling to fit into the box suited for other types of businesses. A next step after traditional lenders is law firms often speak with finance companies and lawyers are often surprised at the interest rates, fees, and terms they are offered. Often by the time they get to a lender like Esquire Bank, the first question that’s asked out of exhaustion and frustration is – what kind of interest rate can you give me? Although our interest rates are some of the lowest in the industry, there’s a lot more to the conversation. There is real value to working with a financial business partner that has a deep understanding of the business of law and the unique financial challenges faced by contingency fee law firms.

NLR: What factors should be considered when assessing case-cost financing?

Kornhaber: First, project your firm’s cash flow for the next 12, 24, and 36 months. Take into consideration the reduction of new case intakes and possible court delays to figure out what your financial position is going to look like over the next few years. Ask yourself what you need to survive, then what you need to thrive and invest during a ‘down market’ to come out on top. Being realistic is extremely important.

Understand how much money you have out on the street today in your case costs, then figure out how much more money you’ll need to spend on case costs over the next 12 months. This helps you to understand what you will need to commit from your self-financed ‘piggy bank’ to continue your winning record for your clients.

Then, figure out what your average balances are in your depository accounts. If you take this information to your lender, they may try to help you in a meaningful way, especially if you’ve been with them for many years.

Finally, ask yourself if you really need to pay for your clients’ case costs using your firms’ after-tax dollars and whether you could instead, use that money more effectively in other activities that will help your law firm grow. Law firms that leverage case-cost financing often report that they achieve better results for their clients because they have the financial backing to go toe-to-toe with their deep-pocketed adversaries without having to think twice about bringing in the best, most expensive experts. That leads to the greatest results and ultimately justice and maximum compensation for their clients.

  • Ari Kornhaber is the Executive Vice President & Head of Corporate Development at Esquire Bank. Join Ari and a panel of experts at Esquire’s upcoming complimentary webinar, ‘Bold Moves: Growing your Contingency Fee Law Firm Post-Pandemic’ on June 15: Save your spot.

Copyright ©2021 National Law Forum, LLC

ARTICLE BY Tracey Goldvarg of The National Law Review / The National Law Forum LLC
For more articles on plaintiff firm financing, visit the NLR Law Office Management section.

Stimulus Bill Extends the Availability of Student Loan Forgiveness (US)

Section 2206 of the CARES Act allowed an exclusion of up to $5,250 from an employee’s gross income, if an employer paid principal or interest on an employee’s “Qualified Education Loan”.

Section 2206 of the CARES Act was only designed to be in effect for calendar year 2020. However, The Consolidated Appropriations Act, 2021 (the “CAA”) extends this provision of the law through December 31, 2025.

This provision of the CAA is in Section 120 of Division EE, called “The Taxpayer Certainty and Disaster Tax Relief Act of 2020”.

It does not appear that during 2020, many employers decided to provide student loan forgiveness as an employee benefit. Given the pandemic, that is certainly understandable. However, going forward, it might be something that employers might find more attractive as a recruiting or retention tool. Thus, the following is a brief refresher on this benefit.

Code Section 127 – Education Assistance Programs

Internal Revenue Code (the “Code”) Section 127 has for a very long time, provided an exclusion from an employee’s gross income for reimbursement provided to the employee under an employer’s “educational assistance program”. The maximum amount of tax-free reimbursement is $5,250 per calendar year.

The employee’s education under the program may be reimbursed without regard to whether it relates to the employee’s employment. However, the educational expenses cannot pertain to a sport, game or hobby.

The CARES Act

Section 2206 of the CARES Act amended Code Section 127 to allow an employer to pay for all or part of an employee’s “Qualified Education Loan” as a tax-free benefit, provided that benefit is provided as part of an employer’s education assistance program.

An important point to note is that the employee would not have had to incur the educational expenses while that person was an employee of the employer.

For example, an existing employee with student loan debts that were incurred prior to be being hired, can have that debt forgiven under the plan. Likewise, a newly hired employee with pre-existing student loan debt can also have that debt forgiven under the plan.

Code Section 127 – Employer Plan Requirements

Under Code Section 127, the employer must establish a written plan and communicate the terms of that plan to eligible employees. In addition, the Plan must satisfy the following requirements:

  • The terms of the Plan cannot discriminate in favor of highly compensated employees (“HCEs”).
  • For this purpose, Code Section 414(q) is referenced. In 2021, an employee is an HCE if he or she had compensation of more than $130,000 in 2020. 5% owners of businesses are also considered to be HCEs.
  • Collectively bargained employees must be considered in determining nondiscrimination eligibility requirements, unless educational assistance benefits were the subject of good faith bargaining.
  • Controlled group rules apply for testing nondiscrimination.
  • The calendar year $5,250 maximum exclusion for loan forgiveness must be combined with any other educational assistance that is provided to the employee under the employer’s Code Section 127 plan for that calendar year.
  • The plan cannot permit an employee to choose between taxable compensation and benefits and the educational assistance. Thus, an employee cannot elect salary reduction as a means of participating in the Section 127 plan. Simply put, the benefits under the plan have to be employer paid benefits.

Qualified Education Loans

The rules that define what will qualify as a “Qualified Education Loan” are somewhat complex. The IRS advises taxpayers to review Chapter 4 of IRS Publication 970.

However, in general, the loan had to be incurred for the employee’s costs of attendance (i) in pursuit of a degree, certificate, or other program that would lead to a “recognized educational credential”, and (ii) while carrying a course load at least one-half (1/2) of the normal course load for that particular course of study.

Loans from the government or a financial institution are fine. Loans from family members don’t qualify. Loans from tax-qualified employer retirement plans (e.g. 401(k) Plans) don’t qualify.

Attendance at an “eligible education institution” is required. In general, this will include all colleges, universities, vocational schools and other post-secondary institutions that are eligible to participate in the federal student aid program.

Costs of attendance at the eligible education institution include tuition and fees, books, supplies, transportation, miscellaneous personal expenses, room and board and various other costs.

© Copyright 2020 Squire Patton Boggs (US) LLP

ARTICLE BY Gregory J. Viviani and Joseph P. Yonadi, Jr. of Squire Patton Boggs (US) LLP
For more, visit the NLR Coronavirus News section.

Congress Passes COVID-19 Relief and Stimulus Package

On Monday, December 21, Congress enacted a $900 billion stimulus package to support American workers and businesses impacted by COVID-19. The measure represents a last-minute bipartisan agreement by a lame duck Congress to provide much-needed support as COVID-19 cases continue to rise across the country. Notably, the bill does not include funding to states and local governments, and does not provide any liability protections for businesses related to COVID-19. Those are issues favored by Democrats and Republicans respectively, and were dropped in the compromise.

The legislation includes funding for individual stimulus checks, a restart and expansion of the popular Paycheck Protection Program (PPP) (including clarification that business expenses paid with PPP loan funds are tax deductible), other new and expanded SBA loan programs, direct targeted funding to certain industries, unemployment compensation program extensions, payroll and other tax credits and deductions. The overall legislation will take effect when signed, but individual programs and provisions may have unique effective dates that are separate from the general effectiveness date.

While President Trump has until December 28 to sign the legislation into law, on Tuesday evening, December 22, he called upon Congress to enact an amendment to increase the amount of payments to individuals from $600 to $2000.  He has also expressed discontent with other provisions of the bill, causing some uncertainty as to whether he will sign it or force Congress to take further action.

​Given this uncertainty, we recognize that certain provisions of the bill may change. However, we know that these Congressional stimulus and relief efforts are of great interest to our clients, and we will continue to keep you apprised of any changes to the legislation and its final outcome. The following summaries are based on the version of the law enacted by Congress on December 21.

For a comprehensive review of these provisions and more, please see the following Pierce Atwood alerts:

Business and Tax Relief – including the PPP, other SBA lending, targeted financial aid to certain industries, and payroll and business tax credits and deductions.

Energy Investment Stimulus – including clean energy reforms, research and development, and extension and enhancement of renewable energy tax credits.

Individuals, Families and Workers Relief – including direct stimulus payments and unemployment programs.

Health Care Providers, Patients, COVID-19 Mitigation, and Vaccination – including additional grant money for providers, ending surprise medical billing, and additional support for COVID-19 mitigation.

©2020 Pierce Atwood LLP. All rights reserved.
For more, visit the NLR Election Law / Legislative News section.

ICE COLD MOVE: US Government Warns of Cybercriminals Targeting Cold Supply Chain for COVID-19 Vaccine

No supply chain is immune from cyberattacks.  This includes, unfortunately, in regards to the COVID-19 vaccine.

Yesterday the US Homeland Security Department issued a warning that a series of cyberattacks is underway aimed at the companies and government organizations that will be distributing coronavirus vaccines around the world.  Specifically, the attacks target the COVID-19 cold chain (an integral part of delivering and storing a vaccine at safe temperatures).

The warning cautions that “[i]mpersonating a biomedical company, cyber actors are sending phishing and spearphishing emails to executives and global organizations involved in vaccine storage and transport to harvest account credentials.  The emails have been posed as requests for quotations for participation in a vaccine program.”  It is unclear at this time whether these attacks are for purposes of stealing the technology for keeping the vaccines refrigerated in transit or for sabotaging distribution of the vaccine.

Josh Corman, the chief strategist for healthcare at the US Cybersecurity and Infrastructure Security Agency (“CISA”) commented that this underscored the need for all “all organizations involved in vaccine storage and transport to harden attack surfaces, particularly in cold storage operation, and remain vigilant against all activity in this space.”

Although this warning was specific to the COVID cold supply chain, all organizations should take note as the core strategies utilized by cybercriminals cut across industries.

© Copyright 2020 Squire Patton Boggs (US) LLP
For more articles on cybercrime, visit the National Law Review Corporate & Business Organizations section.