Upstream Assessment of Downstream Export Issues

October 21st, 2014

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

Your company is a midsize manufacturer of computer network hardware and software, some of which is really cutting-edge technology. A significant portion of your products is exported overseas, either by you directly or by your U.S. distributors. For these U.S. distributors, you ensure that product labeling and literature is in the language of the final user.

You just received a phone call from one of your distributors in Los Angeles. Their customer in Hong Kong just called and told them that officials from the U.S. Department of Commerce just conducted an “end-use check” there in Hong Kong and found “major problems” involving your products. Your distributor is letting you know, so that you can take what your distributor called “appropriate action.”

You don’t know what to do. If there are any problems in Hong Kong, it’s not your problem, right? Especially because this distributor is here in the United States. Should your company be doing something?

Your company needs to take immediate action as a result of this reported “problem.”

If you do nothing, when – not “if,” but “when” – special agents from the Office of Export Enforcement, Bureau of Industry and Security (BIS/OEE) come calling, you will not be prepared and that could result in higher sanctions if they find any export compliance issues at your company.

What risks and/or liabilities do you face?

End-use checks are physical, on-location verifications with the recipient of exported U.S. goods to determine if the party is a reliable recipient of those goods and that items are, or will be, used in accordance with the Export Administration Regulations (EAR). These checks are conducted by the Departments of Commerce, State and Defense, and take place every day in dozens of countries around the world.

If an end-use check found a “major problem” with respect to your company’s merchandise, it could arise from numerous sources. For example, the end-user may have misrepresented itself to the seller or may be transshipping the merchandise illegally. Provided that your company did everything it was supposed to do under the regulations – including investigating red flags, knowing your customer, etc. – you may face little-to-no scrutiny. However, an end-use check could unearth one or more export violation(s) that your company – the manufacturer – may be committing. Depending upon how you manufacture, describe and sell the product, there may be issues with commodity classifications (through CCATS), licenses, etc. Is your company publishing inaccurate Export Control Classification Number (ECCN) or license information on its website and inviting your distributors and customers to rely on such data? This could lead to problems for you.

Moreover, you state that you are aware that your products are being exported. Remember that under export regulations, “All parties that participate in transactions subject to the EAR must comply with the EAR” (15 C.F.R. § 758.3). Are you taking the steps required to ensure that your distributors and customers are compliant with export regulations? Furthermore, if your company is the exporter of record (aka, the U.S. Principal Party in Interest or “USPPI”), you are ultimately responsible for the electronic export information (EEI) that is being filed through the Automatic Export System (AES) and for all classification and license matters.

What should your company do?

Knowing that there is a downstream problem with your exports, it is highly prudent that your company conducts an immediate self-assessment of its export compliance activities-but remember that time is of the essence; if BIS is aware of issues with your exports, it is only a matter of time before they come to call.

You should start by examining the particular transaction(s) involved with this customer. You should be looking to ensure that any export information (e.g., ECCNs, license information) you provided to the customer and/or the distributor was accurate and complete. Expanding your assessment radially, you should examine any and all transactions with this customer, this distributor, and the product(s) involved to ensure that transaction is being performed in accordance with your export compliance management program (ECMP). Then, as time allows, you can review your overall ECMP and perform audits on other, randomly selected export transactions to ensure compliance. An excellent resource to help organize and conduct your company’s self-assessment is the audit module tool developed by BIS. (Click here to view the tool.)

Once you have conducted a thorough self-assessment, you will know if there are any issues with your export compliance program and the export of this product, through this distributor, to this end-user. At that point, you can assess whether any issues you find are systematic problems with your export compliance plan or anomalies that need to be isolated. Regardless of their nature, any issues you find need to be well documented and fixed at once.

As you are remediating any issues you find, your company can decide whether it wants to make any voluntary self-disclosures (VSDs) to BIS. BIS strongly encourages VSDs from exporters, and such disclosures usually result in significant mitigation of any monetary penalties or other sanctions. That said, there are risks to a company making a voluntary self-disclosure and these risks need to be weighed against the benefits.

Also, because your company’s technology is “cutting edge,” your products may embody proprietary, “trade secret” information (such as product materials, designs, and algorithms). Moreover, the end-user and/or your distributor may have commercially sensitive information belonging to your company, such as pricing, training and use information. Because some of this trade secret or commercially sensitive information could be made public during the course of an investigation, you may need to notify BIS/OEE of the need to protect this information from disclosure. Generally, BIS can take steps to help ensure that any disclosure of protected information is tightly controlled. But certainly, the more your company propounds the need for confidential treatment with BIS, the more likely it is that such information will be protected to your satisfaction.

In short, when it comes to export transactions, whether you are the manufacturer, the distributor, the freight forwarder, any other “middle man” or the end-user, compliance with export regulations is always your responsibility, and any “problems” in these transactions should always be addressed as if they were your problems.

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Florida Litigation Update: Appeals Court Clarifies Procedure to Execute Against Alcoholic Beverage License

October 21st, 2014

On September 23, 2014, Florida’s First District Court of Appeal issued its opinion in VMI Entertainment, LLC v. Westwood Plaza, LLC, et. al. clarifying the procedure to execute against a judgment debtor’s alcoholic beverage license.

But first, some background:  Westwood, as landlord, leased commercial property to VMI, as tenant.  Thereafter, VMI defaulted on the lease agreement and, as a result, became indebted to Westwood.  In execution proceedings, Westwood obtained a Writ of Attachment pursuant to Fla. Stat. § 76.01, which provides as follows: “Any creditor may have an attachment at law against the goods and chattels, lands, and tenements of his or her debtor under the circumstances and in the manner hereinafter provided.”  The Writ of Attachment specifically included reference to VMI’s alcoholic beverage license.  VMI moved to dissolve the Writ of Attachment; however, the trial court denied VMI’s request.  VMI appealed.

On appeal, Florida’s First District Court of Appeal considered the issue of whether an alcoholic beverage license may be the subject of a writ of attachment.  In ruling that the license could not be attached, the Court relied in part upon Fla. Stat. § 561.65(4), which sets forth the manner by which a lien or security interest in a “spirituous alcoholic beverage license” may be enforceable against the license. Fla. Stat. § 561.65(4) states that the party which holds the lien or security interest must, within ninety (90) days of the date of creation of the lien or security interest, record same with Florida’s Division of Alcoholic Beverages and Tobacco of the Department of Business and Professional Regulation using forms authorized by the division.  The Court also relied on Florida Supreme Court jurisprudence for two propositions:  First, Fla. Stat. 561.65(4) provides the exclusive means of perfecting a lien on an alcoholic beverage license, and second, a specific statute (Fla. Stat. §561.65(4)), controls over a general one (Fla. Stat. § 76.01).

Ultimately, the Court held that an alcoholic beverage license is not subject to attachment pursuant to Fla. Stat. § 76.01. Instead, the Court ruled, in order to attach an alcoholic beverage license, the creditor must follow the procedure set forth by Fla. Stat. § 561.65(4). Accordingly, the Court reversed the trial court’s order denying VMI’s motion to dissolve the writ (insofar as it encompassed VMI’s alcoholic beverage license) and remanded for entry of an order consistent with its opinion.

The attorneys at Fuerst Ittleman David and Joseph, PL have the experience necessary to perfect and liquidate an alcoholic beverage license lien.  If you have any questions, an attorney can be reached by emailing us at contact@fuerstlaw.com or by calling 305.350.5690.

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Tax Litigation Update: Ninth Circuit Decision Provides Significant Support for Taxpayers Seeking to Discharge Tax Debt in Bankruptcy

October 20th, 2014

On September 15, 2014, the United States Court of Appeals for the Ninth Circuit issued a landmark decision strongly favoring debtors seeking to discharge tax debt in bankruptcy.

The case, Hawkins v. Franchise Tax Board (In Re Hawkins), involved a taxpayer, Trip Hawkins, seeking to discharge roughly 19 million dollars in a Chapter 11 bankruptcy.  The Government objected to the discharge under 11 U.S.C. § 523(a)(1)(C), which precludes the discharge of a tax debt “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”  The Government, which prevailed at the bankruptcy court and district court levels, argued that Hawkins’ level of spending while his tax debt remained outstanding constituted a willful attempt to evade or defeat his tax liability.

Overruling the bankruptcy court and district court decisions below, the Ninth Circuit held that in order for a tax debt to be precluded from discharge due to a willful attempt to evade or defeat the tax, the Government must establish that the debtor had the specific intent to evade payment of tax; mere overspending on other items while the tax debt remained outstanding, if the overspending did not occur with the specific intent of avoiding payment of tax, is insufficient to rise to requisite level of willfulness.

Background

Hawkins’ background created a less than sympathetic picture, which may have had some effect on the lower courts’ decisions to bar discharge.  Hawkins was a graduate of Harvard and Stanford who had been among the first employees of Apple Computers and later served as CEO (and significant stockholder) of Electronic Arts (EA), the noted video game manufacturer.  Hawkins’ wealth grew to about $100 million.  In 1990, EA created a wholly owned subsidiary called 3DO for the purpose of developing and marketing video games and game consoles, and Hawkins was put in charge of 3DO.  Thereafter, Hawkins sold a large amount of his EA stock and used the proceeds to invest in 3DO.  By selling his EA stock, Hawkins generated significant capital gains.  In order to offset his capital gains liability, Hawkins invested in several tax shelters offered by KPMG.  The IRS challenged the tax shelters in 2001 and disallowed the losses Hawkins had taken to offset his capital gains, resulting in millions of dollars of liability for Hawkins.  At the same time, 3DO’s business was stuttering, further compounding Hawkins’ financial situation.  In a 2003 state court filing seeking to reduce his child support obligations, Hawkins acknowledged that he owed $25 million to the United States in back federal income taxes.  All the while, even after recognizing the severity of his tax debt, Hawkins had enjoyed an expensive lifestyle, spending somewhere between $500,000 and $2.5 million more than what he earned on personal expenses in the 33 months between January 2004 and September 2006 when the bankruptcy petition was filed.

Hawkins did make some efforts to reduce his tax liability; he sold his house in July 2006 and paid all of the net proceeds, $6.5 million, toward his tax debt.  Hawkins also proposed an Offer in Compromise of $8 million in an effort settle the liability, but the IRS rejected the offer.  In September 2006, Hawkins filed for Chapter 11 protection, primarily in an attempt to rid himself of his tax debt.  Shortly after filing, Hawkins sold a vacation house for $3.5 million and paid the proceeds to the IRS.  The IRS also received a distribution of $3.4 million in Hawkins’ Chapter 11 plan.  Nevertheless, millions of dollars of tax debt remained outstanding and the United States objected to the discharge of the tax debt on the basis that Hawkins willfully attempted to evade or defeat his tax liability, again arguing that Hawkins’ extravagant spending evidenced his willfulness.

The United States prevailed on this argument at both the Bankruptcy Court and District Court levels, and Hawkins appealed to the Ninth Circuit.

Governing Law

The Bankruptcy Code generally permits a discharge of all pre-petition liabilities of a debtor, unless discharge is specifically precluded by the Bankruptcy Code.  Discharging income tax debt is possible, but doing so requires the debtor to overcome several hurdles.  In addition to meeting several timing requirements contained in § 523(a)(1)(A)-(B) (for instance, the tax at issue must have been based on a return due at least three years before the petition date and the return must have been timely filed and filed more than two years prior to the petition date), the debtor’s return must not be fraudulent and the debtor must not have willfully attempted to evade or defeat the tax at issue.

In many cases, the timing and non-fraudulent return requirements are clearly satisfied, and the outcome of the dischargeability determination hinges solely on whether the debtor willfully attempted to evade or defeat the tax at issue.  Courts are in near universal agreement that the phrase “willfully attempted in any manner to evade or defeat such tax” contains two elements the Government must prove: a conduct requirement and a mental state requirement.  The conduct requirement means that the Government must prove that the debtor engaged in some act or omission in an attempt to evade or defeat the tax.  The Government must also prove that the debtor committed the act or omission willfully.

The Hawkins case dealt solely with the mental state requirement, more specifically the mental state required by the statute’s use of the word “willfull” in order to preclude discharge.  A majority of Courts, including the Eleventh Circuit, have adopted a test which requires the Government to show that the debtor (1) had a duty to pay taxes under the law; (2) knew that he had such a duty; and (3) voluntarily and intentionally violated that duty.  These courts have not expressly required the Government to establish that a debtor had a specific, fraudulent intent to evade or defeat the tax.

In reversing the bankruptcy court and district court in Hawkins, the Ninth Circuit set forth a more restrictive, debtor-friendly interpretation of willfulness.  Specifically, the Court held that “we conclude that declaring a tax debt dischargeable under 11 U.S.C. § 523(a)(1)(C) on the basis that the debtor ‘willfully attempted in any manner to evade or defeat such tax’ requires showing of a specific intent to evade the tax.  Therefore, a mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took action the actions with the specific intent of evading taxes.”  In other words, to the Ninth Circuit, overspending alone will not rise to willfulness unless the debtor overspent with the specific intent of avoiding payment of his tax liability.

In reaching this conclusion, the Ninth Circuit focused on purpose of the Bankruptcy Code and the textual structure of § 523(a)(1)(C).  First, the Ninth Circuit emphasized the fact that federal bankruptcy law was designed to provide debtors with a fresh start, which in turn compels a strict, rather than expansive, interpretation of “willfulness.”  For support, the Ninth Circuit cited Kawaauhau v. Geiger, 523 U.S. 57 (1998), in which the Supreme Court held that, under § 523(a)(6) of the Bankruptcy Code, which precludes discharge of debts arising out of a willful and malicious injury, the party seeking to preclude discharge must establish an intent to injure, not just an intentional act that leads to injury.

The Ninth Circuit also relied on the text of § 523(a)(1)(C) in requiring a higher standard of willfulness.  The Ninth Circuit held that by grouping willfulness with the filing of a fraudulent return in a separate subsection, rather than the more banal timing requirements of § 523(a)(1)(A)-(B), Congress had evidenced its intent to require a showing of bad purpose on the part of the debtor for the Government to establish willfulness.

The Court also found support for its ruling in the Internal Revenue Code.  Specifically, the Court highlighted the fact that the language of § 523(a)(1)(C) is nearly identical to that found in IRC § 7201, which makes it a felony to “willfully attempt in any manner to evade or defeat any tax.”  Courts interpreting § 7201 have required the Government to prove that the taxpayer voluntarily and intentionally violated a known legal duty.  See Cheek v. United States, 498 U.S. 201 (1992).  This, “almost invariably,” will “involve deceit or fraud upon the Government, achieved by concealing tax liability or misleading the Government as to the extent of the liability.”  Kawashima v. Holder, 132 S. Ct. 1166, 1175, 1177 (2012).  In following this rationale, the Ninth Circuit rejected reasoning of other Circuit Courts facing this question which have relied upon portions of the Internal Revenue Code dealing with civil willfulness (such as IRC § 6672).  Generally speaking, civil willfulness requires the Government to establish intentional conduct, but not a bad faith purpose, while criminal willfulness requires a bad faith purpose.

The Ninth Circuit also focused on the consequences of imposing a rule providing that living beyond one’s means would lead to the preclusion of tax debt dischargeability.  “Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable.  Such a rule could create a large ripple effect throughout the bankruptcy system.”

In sum, the Ninth Circuit held that acts that detract from a debtor’s ability to pay the outstanding tax debt will not preclude discharge unless those acts are made with the specific intent of evading tax.  Intending to commit the act (or omission) that detracts from payment of the outstanding tax is not by itself sufficient.

Conflict with Other Circuits?

As stated above, several Circuit Courts of Appeal have read § 523(a)(1)(C) to require the Government to prove that the debtor (1) had a duty to pay taxes under the law; (2) knew he had that duty; and (3) voluntarily and intentionally violated that duty.  Under a broad interpretation, those elements are arguably satisfied if the act of overspending was committed intentionally, but without the specific purpose of avoiding taxation.

From a surface level it appears that the Ninth Circuit’s Hawkins decision creates a Circuit split, because the Ninth Circuit now requires the Government to prove specific intent to establish willfulness while a number of other Circuits have not expressly made that a requirement.  However, as the Court points out in Hawkins, in those other Circuits, living a lifestyle beyond one’s means has always been coupled with some other act or omission designed to evade taxes, such concealing assets, a failure to file returns and pay taxes, and structuring financial transactions to avoid currency reporting requirements.  Prior to Hawkins, no Circuit Court had directly answered the question of whether a taxpayer that files timely, accurate returns and does not engage in acts of deceit but spends beyond his means is willful under § 523(a)(1).  In that regard,Hawkins can be seen as a case of first impression and its reasoning is applicable across the country.

Moreover, it can be argued that the Ninth Circuit’s Hawkins decision expressly said what other Courts have said implicitly, or at least in a less forthright manner: where a bankruptcy debtor has lived beyond his means in the face of an existing tax debt, in order for discharge of the tax debt to be precluded, the Government cannot rely on overspending itself and must establish by a preponderance of the evidence some other act designed to evade taxes.

Effect on Eleventh Circuit Cases

The Eleventh Circuit is among the Circuit Courts that applies the three part test set forth above (the debtor had a legal duty to pay tax, knew of the legal duty, and voluntarily and intentionally violated that duty) in determining whether the mental state requirement of § 523(a)(1) has been satisfied.  Put more succinctly, “a debtor’s tax debts are non-dischargeable if the debtor acted knowingly and deliberately in his efforts to evade his tax liabilities.”  In Re Mitchell, 633 F.3d 1319 (11th Cir. 2011).  Additionally, the Court has stated that “fraudulent intent is not required” in determining willfulness.  In Re Fretz, 244 F.3d 1323 (11th Cir. 2001).

However, the Eleventh Circuit has never held that mere lavish spending in the face of a tax debt is sufficient to bar discharge.  Some evidence of a debtor’s deceit has always been present.  In both Mitchell (failure to file, titling assets in nominee names, reincorporating to avoid garnishment) and Fretz (failure to file), other factors contributed to the determination that the debtor satisfied the willfulness requirement.  Overspending alone was not determinative.  Therefore, Hawkins does not serve as directly contrary authority to the Eleventh Circuit’s approach to determining willfulness, but it does lend significant support to combat any argument the Government may raise in an attempt to establish willfulness based solely on overspending.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax and tax litigation in the Tax Court, the Federal District Courts, and Bankruptcy Courts.  They will continue to monitor developments in the Hawkins case and this area of the law generally. If you have any questions, an attorney can be reached by emailing us at contact@fuerstlaw.com or by calling 305.350.5690.

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Exporter Liability for Freight Forwarder Issues

October 10th, 2014

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

You are a small company that exports a wide variety of merchandise all over the world. Years ago, to save money, you contracted out all of your logistics functions to a third-party company which also serves as your warehouse and freight forwarder for export shipments. They take care of all the details of exports for you: licenses, government filings, paperwork…

Today, however, you had a visit from Homeland Security Investigations and the agents said that YOU may have broken the law with regard to certain shipments that were improperly exported. You have a very detailed Services Agreement with your logistics provider and they are responsible for everything. You don’t understand how your company could now be liable for something that your freight forwarder has done!

The question of who is responsible for export compliance, and who may be liable for violations, is very simple and yet may be very complex at the same time. Typically, the “exporter” is responsible for export compliance, but figuring out who exactly is the “exporter” depends on the roles that the various parties in a transaction may play and who may have accepted the mantel of the “exporter” under a contract or agreement.

The EAR defines an exporter as the “person in the United States who has the authority of a principal party in interest to determine and control the sending of items out of the United States” (15 C.F.R. § 772.1). That is why the EAR talks about U.S. Principal Parties in Interest (USPPI) and Foreign Principal Parties in Interest (FPPI). The ITAR does not formally define the term “exporter,” but imposes license and other compliance requirements on “any person who intends to export … a defense article” (22 C.F.R. § 123.1(a)). The FTR adopts the term “USPPI” as the “exporter” of merchandise (15 C.F.R. §30.1(c)). For our purposes here, we will just use the term “exporter.”

In traditional export transactions – and most situations except for “ex works” sales (Incoterms 2012) – the seller of the goods is the exporter. However, both the USPPI/exporter and the FPPI can authorize an agent in the United States to represent them in export transactions; this is where most logistics providers and freight forwarders most often enter the picture.

These agents – which can only act with a proper power of attorney from the exporter – can take over many export responsibilities for the exporter. An authorized agent can enter electronic export information (EEI) into AES and can request and obtain licenses for export. In “routed transactions” the agent can even serve as the “exporter” for export compliance purposes.

However, in all cases except certain routed transactions, using such authorized agents does not relieve an exporter of its legal responsibilities for export compliance or its potential liabilities in the case of most export violations.

The exporter of merchandise from the United States (the USPPI/FPPI) ultimately bears the responsibility for:

  • providing the agent with accurate EEI for the merchandise being exported;
  • determining the commodity jurisdiction of the merchandise;
  • determining the export classification (under the CCL and USML) of the goods;
  • determining license requirements (BIS/DDTC/OFAC); and
  • keeping all required export records.

Even a detailed Services Agreement that may shift all of these duties onto a freight forwarder does not mean that the exporter is not still responsible and liable for these obligations under U.S. export laws. In our experience, federal export enforcement officials truly frown on exporters that try to make their freight forwarder solely responsible for export compliance. This practice usually results in higher sanctions for exporters when violations are found.

Given that you can never relieve yourself of export compliance responsibilities and liabilities, what should exporters do to effectively manage their third-party freight forwarders and mitigate their compliance risks?

  1. Own your company’s export compliance. Your company – and not your agent – should be responsible for jurisdiction, classification and license determinations, as well as for consignee/end-user screening. Also, you should know exactly who has powers of attorney to act on your behalf in export transactions.
  2. Accurately convey information regarding each shipment. Using an old-school Shipper’s Letter of Instruction (SLI) (or providing the equivalent information in another form) for each export transaction helps ensure that your freight forwarder has the most recent, accurate, and complete information for export shipments.
  3. Ensure you receive export documentation, then audit transactions. You must ensure that you receive copies of shipping documents, AES entry summaries and supporting documents (licenses, special certifications, etc.) for every export shipment. Then, you must periodically audit the shipment information against your invoices, purchase orders and the SLI to make sure that exports are being correctly handled.
  4. Do your due diligence, and keep it up. From the moment you select your freight forwarder, until the day the relationship ends, you should be in constant contact with your agent to understand their business, assess their general compliance posture and ensure that they are taking export compliance as seriously as you are.

While an exporter can never totally relieve itself of liability for the acts and omissions of its authorized agent in export transactions, following the steps above should greatly mitigate any potential risks and liabilities that your company may face in the event that there are problems.

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Third Circuit decision highlights power of “good faith exception” to the exclusionary rule

October 8th, 2014

We previously discussed the decision of the United States Court of Appeals for the Third Circuit in United States v. Katzin, wherein the Court found that a warrant is required for GPS monitoring and that there was no good-faith exception to the exclusionary rule.  However, on October 1, 2014, the Third Circuit sitting en banc  overruled the decision of the three judge panel and held that although a warrant is required to use a GPS monitor, because the state of the law before the Supreme Court’s 2012 decision in United States v. Jones supported the FBI agent’s action, the exclusionary rule did not apply.

The Good Faith Exception to the Exclusionary Rule

By reversing its earlier decision, the Third Circuit joined the Second, Fifth Seventh, and Ninth Circuits which have also held that the use and installation of a GPS device without a warrant prior to the Supreme Court’s Jones decision did not require the suppression of the evidence because of the “good faith exception” to the exclusionary rule. Consistent with the Supreme Court’s decisions in Knotts and Karo, both of which stand for the proposition that law enforcement searches which are conducted with an objectively reasonable reliance on binding appellate precedent are not subject to the exclusionary rule, the Third Circuit ruled that the FBI agent acted in good faith reliance upon Jones and therefore the good faith exception to the exclusionary rule applied. In other words, even though the agent’s search was subsequently deemed to be unlawful, because at the time of the search he relied in good faith on binding judicial precedent, the evidence obtained as the fruit of that “unlawful” search was nevertheless allowed to be used against the defendant from whom it was obtained.

As explained by the Third Circuit sitting en banc, the recent trend in Supreme Court jurisprudence is to limit the scope and application of the exclusionary rule to those “unusual cases” in which the suppression of illegally obtained evidence may “appreciably deter governmental violations of the Fourth Amendment.” Indeed, as the Third Circuit observed, the cost of suppressing illegally obtained evidence is that evidence of a criminal defendant’s guilt, even though reliable and trustworthy, will not be admitted “thereby ‘suppress[ing] the truth and set[ting] [a] criminal loose in the community without punishment.”

The Ramifications

Law enforcement’s ability to avoid the suppression of evidence has been dramatically expanded. Katzin and similar decisions in other federal courts are incredibly powerful means for law enforcement to circumvent the Fourth Amendment. Thus, in all criminal cases where a defendant attempts to challenge evidence based upon law enforcement’s clear violations of the defendant’s Fourth Amendment rights, one should anticipate the prosecution’s attempt to establish that law enforcement relied in good faith upon some binding appellate precedent, even if that precedent has since been overruled.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience litigating and trying criminal cases both at the state and federal levels including before the United States Courts of Appeal.  You can contact us via email:  contact@fuerstlaw.com or via telephone:  305.350.5690.

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Bitcoin Update: Recent Decision May Provide Roadmap for Calculating Damages Associated with Bitcoin Related Litigation

October 8th, 2014

On September 18, 2014, the United States District Court for the Eastern District of Texas issued its order granting summary judgment in favor of the United States Securities and Exchange Commission (“SEC”) in the case of SEC v. Shavers, Case No. 4:13-00416 (E.D. Tx. September 18, 2014). While at first glance, the decision may appear to be nothing more than another uncontested motion for summary judgment, the decision is important for the bitcoin industry for several reasons. First, the District Court found that investments in bitcoin can constitute “investment contracts” and thus, “securities” under 15 U.S.C. § 77b the Securities Act of 1933. Second, the Court’s analysis in calculating a reasonable approximation of profits in U.S. dollars from the bitcoin based scheme can provide a roadmap for calculating bitcoin related damages in future litigation.

In its Complaint, the SEC alleged that Shavers violated sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and section 10(b) and Rule 10b-5 of the Exchange Act, codified at 15 U.S.C. § 77(c) related to his running of a bitcoin investment scheme. As described by the District Court in its Order, the SEC alleged that Shavers founded and operated Bitcoin Savings and Trust (“BST”). From at least February 2011 through August 2012, Shavers sold investments in BST falsely promising investors up to 1% interest daily or 7% interest weekly, purportedly based on Shavers’ trading of bitcoin against the U.S. dollar. What made Shavers’ scheme unique is that he solicited and accepted all investments, and paid all purported returns in Bitcoin. Ultimately, Shavers received at least 732,050 bitcoin in investments of which 180,819 bitcoins constituted ill-gotten gains.

In response to the SEC’s Complaint, Shavers filed a Motion to Dismiss arguing that the District Court lacked subject matter jurisdiction because the investments in BST did not constitute securities under the Securities Act of 1933. More specifically, Shavers argued that 1) bitcoin is not money and is not part of anything regulated by the United States; and 2) that because all transactions were solely in bitcoin, no money ever exchanged hands, thus the investments could not constitute investment contracts and there were not “securities” under the act. [15 U.S.C. § 77b defines “security” as “any note, stock, treasury stock, security future, security-based swap, bond . . . [or] investment contract . . . .” In turn, for purposes of the Securities Act of 1933, an “investment contract” is any contract, transaction, or scheme whereby: 1) a person invests money; 2) in a common enterprise; and 3) is led to expect profits solely from the efforts of the promoter or a third party. See SEC v. W.J. Howey & Co., 328 U.S. 293, 298-299 (1946).]

In denying Shavers Motion to Dismiss and rejecting his arguments, the District Court noted:

It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in [BST] provided an investment of money.

Thus, because bitcoin was used as money, the investments in BST constituted an investment of money and as such, an investment contract under the Securities Act of 1933. Therefore, the District Court found that the investments sold by Shaver constituted “securities” under the Securities Act of 1933. A copy of the District Court’s Order denying Shaver’s Motion to Dismiss can read here.

The Shavers case concluded in the District Court granting the SEC’s unopposed Motion for Summary Judgment. In so deciding, the District Court explained that it enjoyed broad equitable power to order securities law violators to disgorge their ill-gotten gains. However, as Shavers’ scheme solely involved bitcoin, the District Court was tasked with the issue of how to properly determine what constitutes a “reasonable approximation of profits casually connected with the violation.” As noted by the District Court, this task became more difficult in light of the large fluctuations in the exchange rate of bitcoin from the time the Ponzi scheme first started to the ultimate determination of liability. Ultimately, the District Court concluded that a reasonable calculation of disgorgement in U.S. Dollars could be obtained by multiplying the total amount of ill-gotten gains in bitcoin by the average daily price of bitcoin between the time the Ponzi scheme ended and the date of the Court’s ruling. In so calculating, the District Court order Shavers to disgorge $38,638,569. It waits to be seen whether other courts adopt the District Court for the Eastern District of Texas’s logic in calculating bitcoin to U.S. dollar exchanges for judgment purposes in light of bitcoin’s historic volatility. A copy of the District Court’s Order granting summary judgment can be read here.

The Shavers’ decision comes at a time when both federal and state regulators have increasingly turned their attention towards virtual currency. As we have previously reported, New York State has recently proposed a highly detailed regulatory framework for virtual currency businesses. In addition, on August 11, 2014, the Consumer Finance Protection Bureau (“CFPB”) issued a consumer advisory warning customers of the potential risks associated with virtual currencies, including their high volatility and potential use in Ponzi schemes In the same announcement, CFPB announced that it has begun accepting consumer complaints regarding bitcoin transactions and dealings. A copy of our report on CFPB’s announcement can be read here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. If you or your company has a question related to its anti-money laundering compliance obligations, our anti-money laundering attorneys can provide further information. You can reach an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690

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Bitcoin Regulatory Update: CFPB Issues Consumer Advisory Regarding Virtual Currencies, Begins Accepting Complaints

September 1st, 2014

On August 11, 2014, the Consumer Finance Protection Bureau (“CFBP”) issued a consumer advisory warning customers of the potential risks associated with virtual currencies. A copy of the CFBP press release can be read here.

Created with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, CFPB, which began operations on July 21, 2011, was tasked with the responsibility of regulating both banks and nonbank institutions which offer financial products or services to ensure that these institutions comply with federal consumer financial protection laws. Under the Dodd-Frank act, CFPB is authorized to supervise all banks with more than $10 billion in assets as well as all sizes of nonbank mortgage companies, payday lenders, and private education lenders. Dodd-Frank also grants CFPB the power to regulate nonbank institutions in other consumer financial services markets.

CFPB’s consumer advisory does two things. First, it provides consumers a series of warnings and risks to be considered prior to entering into the virtual currency marketplace. According to CFPB, among the issues that consumers should be aware of prior to entering the virtual currency market include: 1) virtual currency is not a legal tender, not backed by any government, and digital wallets used to store such currency are not FDIC insured; 2) the exchange rate for virtual currency vis-à-vis fiat currency is very volatile and virtual exchanges may also charge additional mark-ups and fees for exchange and wallet services; and 3) digital wallets are the target of cyber-attacks and hackers and loses may not be recoverable.

Second, CFPB announced that consumers who encounter problems with virtual currency services and products can now file a complaint with the agency. As explained by CFPB, after it receives a complaint “[t]he CFPB will send the complaint to the appropriate company, and will work to get a response. If the complaint is about an issue outside the CFPB’s jurisdiction, the CFPB will forward the complaint to the appropriate federal or state regulator.” Such other federal agencies may include the Financial Crimes Enforcement Network, which regulates virtual currency exchanges, the Federal Trade Commission, which regulates unfair and deceptive trade practices, and the Securities and Exchange Commission. (Copies of recent SEC investor advisories regarding virtual currencies can be read here and here.) The CFBP’s consumer advisory can be read here.

CFPB’s advisory comes in the wake of the recent announcement by New York State of its proposed framework for the regulation of virtual currency businesses. As we previously reported, included in the various proposed consumer protection regulations was the requirement that virtual currency businesses provide “clear and concise disclosures” to its consumers about each of the above mentioned risks. New York’s proposed BitLicense and now CFPB’s advisory are early steps in a growing trend of attempts to regulate the virtual currency industry. As we have also explained, the nature of the virtual currency business raises unique challenges for federal regulators seeking to curtail money laundering and state regulators seeking to protect residents from unfair, deceptive, and unscrupulous business practices. Of course, as more and more agencies seek to regulate the virtual currency service, the more likely it becomes that the resulting regulations are inconsistent with one another, leading to confusion in the industry and stifling growth.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. If you or your company has a question related to its anti-money laundering compliance obligations, our anti-money laundering attorneys can provide further information. You can reach an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690

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International Tax Compliance Update: Renouncing U.S. Citizenship to Avoid Taxes: Is It Worth It?

August 13th, 2014

As we have reported previously (see here, here, here, and  here) in recent years the United States has intensified its efforts to force United States persons to disclose assets they hold and income they earn abroad. Two prominent examples of these efforts are the United States’ increased focus on imposing penalties and people for failing to file Foreign Bank Account Reports (FBARs), and the passage and impending implementation of the Foreign Account Tax Compliance Act (FATCA), Internal Revenue Code §§ 1471-1474. The primary objective of these efforts is to ensure U.S. citizens and residents are accurately reporting their income and paying the correct tax. U.S. persons who fail to do so face serious consequences, which can include not only additional taxes, but also penalties, interest, fines and even imprisonment.

The United States taxes its citizens on worldwide income, no matter where they live and regardless of how long they have been overseas. Further, the rules for filing income, estate and gift tax returns and for paying estimated tax are generally the same whether the U.S. citizen is living in the U.S. or abroad. In addition to reporting their worldwide income, U.S. citizens must also report on their U.S. tax return whether they have any foreign bank or investment accounts.  As we previously reported, the Bank Secrecy Act requires U.S. persons to file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR), if (1) they have financial interest in, signature authority, or other authority over one or more accounts in a foreign country, and (2) the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

To avoid paying taxes to the U.S. government and the civil and criminal penalties associated with not disclosing foreign income or accounts, many U.S. citizens living abroad consider raising their right hand and reciting an oath renouncing their U.S. citizenship. As we have reported, over the past years there has been a significant surge in the number of Americans renouncing their U.S. citizenship. However, in terms of dollars and cents, this may well be a worse option than paying their taxes and reporting their foreign financial accounts to the IRS.

The expatriation tax provisions under Internal Revenue Code (I.R.C.) §§ 877 and 877A apply to U.S. citizens who have renounced their citizenship and long-term residents (as defined in I.R.C. §877(e)) who have ended their U.S. resident status for federal tax purposes. Different rules apply according to the date of expatriation. For U.S. citizens currently considering expatriation, and those who expatriated after June 16, 2008, the new I.R.C. §877A expatriation rules may apply. These rules apply if (1) their average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($147,000 for 2011, $151,000 for 2012, and $155,000 for 2013), (2) their net worth is $2 million or more on the date of your expatriation or termination of residency, or (3) they fail to certify on Form 8854 that they have complied with all U.S. federal tax obligations for the 5 years preceding the date of their expatriation or termination of residency. If any of these rules apply, you are a “covered expatriate.”

All of the property of a covered expatriate is deemed sold on the day before the expatriation date (i.e. the date the individual relinquishes U.S. citizenship) for its fair market value, and the covered expatriate is required to recognize any gain or loss resulting from the deemed sale. I.R.C. §877A(a). This is known as a “mark-to-market” regime.  To determine the gain or loss from a deemed sale, all gains are taken into account notwithstanding any other provision in the Code. Any loss from the deemed sale is taken into account for the tax year of the deemed sale to the extent otherwise provided in the Code, except that the wash sale rules of I.R.C. §1091 do not apply.
The amount that would otherwise be includible in gross income by reason of the deemed sale rule is reduced (but not to below zero) by $600,000, which amount is to be adjusted for inflation for calendar years after 2008 (the “exclusion amount”). For calendar year 2013, the exclusion amount is $663,000. For other years, refer to the Instructions for Form 8854.
The amount of any gain or loss subsequently realized (i.e., pursuant to the disposition of the property) will be adjusted for gain and loss taken into account under the I.R.C. §877A mark-to-market regime, without regard to the exclusion amount. A taxpayer may elect to defer payment of tax attributable to property deemed sold. (For more detailed information regarding the I.R.C. §877A mark-to-market regime, refer to Notice 2009-85.)
Form 8854, Initial and Annual Expatriation Information Statement, and its Instructions have been revised to permit individuals to meet the new notification and information reporting requirements. The revised Form 8854 and its instructions also address how individuals should certify (in accordance with the new law) that they have met their federal tax obligations for the five preceding taxable years and what constitutes notification to the Department of State or the Department of Homeland Security.

A citizen is treated as relinquishing his or her U.S. citizenship on the earliest of four possible dates: (1) the date the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the United States, provided the renunciation is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State; (2) the date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of §349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(1)-(4)), provided the voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State; (3) the date the U.S. Department of State issues to the individual a certificate of loss of nationality; or (4) the date a U.S. court cancels a naturalized citizen’s certificate of naturalization.

A long-term resident ceases to be a lawful permanent resident if the individual’s status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or if the individual: (1) commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, (2) does not waive the benefits of the treaty applicable to residents of the foreign country, and (3) notifies the IRS of such treatment on Forms 8833 and 8854.
Significantly, an individual does not have to be a high net worth individual to fall under the “covered expatriate” rules. As noted earlier, if any of the I.R.C. §877A rules apply, the individual will be considered a covered expatriate. One of those rules states that a taxpayer who fails to certify, under penalties of perjury, compliance with all U.S. Federal tax obligations for the five taxable years preceding the taxable year that includes the expatriation date. This means that if the individual failed to comply with his U.S. federal tax obligations or simply failed to certify that he complied, he will be automatically considered a “covered expatriate” subject to the tax imposed by I.R.C. §877A. Therefore, a close look at the expatriation tax makes evident that raising your right hand to renounce U.S. citizenship may be as costly (if not more) than keeping your U.S. citizenship and paying taxes on your worldwide income like all other U.S. citizens even if you are not considered a wealthy individual. The expatriation tax adds up, potentially to as much as paying income taxes to the IRS will. This raises the question: is paying a significant amount of expatriation tax and giving up one of the most desired citizenships in the world really worth it?

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax and tax litigation.  They will continue to monitor developments in this area of the law. If you have any questions, an attorney can be reached by emailing us at contact@fuerstlaw.com or by calling 305.350.5690.

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Bitcoin Regulatory Update: The BitLicense: New York State Proposes Virtual Currency Licensing and Regulatory Regime

August 1st, 2014
On July 23, 2014, the New York State Department of Financial Services published its proposed framework for the regulation of virtual currency businesses doing business in New York. The proposed “BitLicense” regulations would create a comprehensive regulatory regime over virtual currency businesses including anti-money laundering compliance, cyber security regulations, and various consumer protection safeguards that are commonly seen in the regulation of other state-regulated financial institutions and money services businesses. Once the rules are finalized, New York would become the first state to specifically regulate virtual currency businesses. A copy of the Department of Financial Services press release can be read here.
  1. Introduction
Although the regulation of virtual currency presents real challenges for federal and state regulators because of the nature of the virtual currency industry itself, these challenges are only unique to the extent that regulators have never previously attempted to regulate virtual currencies by name. However, regulators do have a great deal of experience regulating transactions of all shapes and sizes, and it appears that they will rely on that experience in regulating virtual currency transactions. (Our previous report on FinCEN’s attempt to clarify when virtual currency activity constitutes money transmission can be read here.) Further, the risks associated with virtual currency from both a crime prevention and consumer protection standpoint are nearly identical to those commonly associated with more traditional MSB, consumer finance, credit card, and bank transactions. Thus, as the federal and state governments begin the process of regulating the virtual currency industry, it comes as no surprise that regulators are focusing on how virtual currency is used – as opposed to the virtual or digital nature of the thing itself – and will apply requirements commonly seen in the regulation of routine transactions in fiat currencies.
  1. What is a “Virtual Currency” and what activities are regulated.
The proposed regulations broadly define “Virtual Currency” as follows:
Virtual Currency means any type of digital unit that is used as a medium of exchange or form of digitally stored value or that is incorporated into payment system technology. Virtual Currency shall be broadly construed to include digital units of exchange that (i) have a centralized repository or administrator; (ii) are decentralized and have no centralized repository or administrator; (iii) may be created or obtained by computing or manufacturing effort. Virtual Currency shall not be construed to include digital units that are used solely within online gaming platforms with no market or application outside of those gaming platforms, nor shall Virtual Currency be construed to include digital units that are used exclusively as part of a customer affinity or rewards program, and can be applied solely as payment for purchases with the issuer and/or other designated merchants, but cannot be converted into, or redeemed for, Fiat Currency.
See Proposed Rules at § 200.2(m). The proposed rules can be read in their entirety here.
        New York’s proposed BitLicense would be required for any person engaging in “Virtual Currency Business Activity.” Such activity has been defined as follows:
Virtual Currency Business Activity means conduct of any one of the following types of activities involving New York or a New York Resident:
        (1) receiving Virtual Currency for transmission or transmitting the same;
        (2) securing, storing, holding, or maintaining custody or control of Virtual Currency on behalf of others;
        (3) buying and selling Virtual Currency as a customer business;
        (4) performing retail conversion services, including the conversion or exchange of Fiat Currency or other value into Virtual Currency, the conversion or exchange of Virtual Currency into Fiat Currency or other value, or the conversion or exchange of one form of Virtual Currency into another form of Virtual Currency; or
        (5) controlling, administering, or issuing a Virtual Currency.
See Proposed Rules at § 200.2(n). However, merchants and consumers that utilize Virtual Currency solely for the purchase or sale of goods or services and those persons chartered under the New York Banking Law to conduct exchange services and approved to engage in Virtual Currency Business Activity need not require a license.
  1. Anti-Money Laundering Program
The proposed regulations require that each proposed licensee establish and maintain an Anti-Money Laundering Compliance Program. The regulations focus on three main areas: 1) adequate recordkeeping of Virtual Currency Transactions; 2) verification of customer account holders utilizing a licensee’s services; and 3) the reporting of suspected fraud and illicit activity. Regarding recordkeeping, the regulations provide that licensee maintain the following information for all transactions involving “the payment, receipt, exchange or conversion, purchase, sale, transfer, or transmission of Virtual Currency”: 1) the identity and physical address of the parties involved; 2) the amount or value of the transaction; 3) the method of payment; 4) the date(s) on which the transaction was initiated and completed; and 5) a description of the transaction.
Further, as part of its AML program, each licensee must also “to the extent reasonable and practicable,” verify the customer’s identity and maintain a customer identification program. The regulations provide that such identification includes the customer’s name, physical address, and other identifying information including a check of the customer against the Specially Designated Nationals (“SDNs”) list maintained by the Office of Foreign Asset Control (“OFAC”) of the U.S. Department of the Treasury. The regulations also provide that licensees which maintain accounts for non-US Persons must establish enhanced due diligence procedures to protect against money laundering, including assessing the nature of the foreign business and the AML requirements and regimes of the foreign jurisdiction in which the foreign entity operates. Towards that end, the regulations also prohibit the maintenance of accounts for foreign shell entities.
In addition, the proposed regulations would also implement the equivalent of state level Currency Transaction Reports (“CTRs”) and Suspicious Activity Reports (“SARs”) filing obligations on virtual currency businesses. The proposed regulations provide that licensees are required to report to the Department all transactions or series of transactions in the aggregate amount of $10,000 in one day, by one person. The proposed regulations provide that, in addition to SAR filing obligations under federal law, virtual currency businesses would be required to immediately report suspicious transactions which might signal money laundering, tax evasion, or other illegal or criminal activity.
  1. Cyber Security Requirements
The proposed regulations require that each virtual currency business maintain a cyber-security program designed to perform the following: 1) identify internal and external cyber risks; 2) protect the Licensee’s electronic systems from unauthorized access, use, and other malicious acts; 3) detect system intrusions, data breaches, and unauthorized access; and 4) respond to and recover from cyber security breaches and restore the system to normal operation. The proposed regulations also require that each virtual currency business designate a Chief Information Security Officer responsible for overseeing and implementing the Licensee’s cyber security program.
  1. Consumer Protection Regulations
The proposed regulations present a broad array of consumer protection regulations. First, similar to other money services businesses, virtual currency businesses will be required to maintain minimum capital requirements in order to be granted and maintain a BitLicense. Although the precise capital/net worth requirements are not detailed, the regulations address a variety of factors, including anticipated volume of business, total assets versus total liabilities of a licensee, and whether the licensee is already licensed under the Financial Services, Banking or Insurance Laws of New York. The proposed regulations will also require that virtual currency businesses maintain a bond.
Second, the proposed regulations require that each virtual currency business must hold Virtual Currency of the same type and amount as any Virtual Currency owed or obligated to a third party. Towards that end, the selling, transferring, assigning, lending, pledging, or otherwise encumbering assets and Virtual Currency stored by a virtual currency business on behalf of another is strictly prohibited.
Third, the proposed regulations require that the virtual currency business provide “clear and concise disclosures” to its consumers about potential risks associated with Virtual Currency including that: 1) virtual currency is not a legal tender, not backed by the government, and accounts are not FDIC insured; 2) legislative and regulatory changes may affect the use, transfer, exchange, and value of Virtual Currency; 3) transactions in Virtual Currency are generally irreversible, therefore losses due to fraud or accidental transfer may not be recoverable; 4) the price of Virtual Currency vis-à-vis Fiat Currency is volatile and may result in significant losses or tax liabilities over short periods of time; and 5)the nature of Virtual Currency may lead to an increased risk of cyber-attacks.
Fourth, the proposed regulations require that each virtual currency business establish and maintain written complaint resolution policies and procedures. The proposed regulations further provide that virtual currency businesses must provide notice to customers, “in a clear and conspicuous manner,” that customers can bring complaints to the State Department of Financial Services’ attention for further review and investigation.
Finally, the proposed regulations require that virtual currency businesses provide its customers with a detailed receipt at the time of the transaction containing: 1) the licensee’s name and contact information; 2)the type, value, data, and precise time of the transaction; 3) the fee charged; 4) the exchange rate; 5) a statement of the refund policy; and 6) if applicable, a statement of the liability of the Licensee for non-delivery or delayed delivery.
  1. Analysis and Conclusion
New York’s proposed BitLicense regime is the first in what will almost definitely be a growing trend of states attempting to regulate the growing area of virtual currency. While the regulations on their face appear vast, a majority of the requirements that New York seeks to impose on virtual currency businesses have been imposed for decades on money services businesses such as money transmitters, dealers of foreign exchange, check cashers, and payday lenders. However, the nature of virtual currency and the lack of “brick and mortar” institutions engaging in the virtual currency business raise unique challenges for federal regulators seeking to curtail money laundering and state regulators seeking to protect residents from unfair, deceptive, and unscrupulous business practices.
In accordance with the New York Administrative Procedures Act, the proposed rules are currently subject to a 45-day public comment period which began once the proposed regulations were published. At the close of the public comment period, the Department of Financial Services will review the public’s commentary and possibly revise the proposed regulations based on this feedback prior to finalization.
The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. If you or your company has a question related to its anti-money laundering compliance obligations, our anti-money laundering attorneys can provide further information. You can reach an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690.

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Florida Appeals Court Clarifies Law On Derivative And Direct Shareholder Lawsuits

July 22nd, 2014

On July 9, 2014, Florida’s Third District Court of Appeal issued a landmark opinion in the case of Dinuro Investments, LLC vs. Felisberto Figueira Camacho, et al., 3D13-1242 & 3D13-1246, (July 9, 2014).  In Dinuro, the Court analyzed whether a member of a limited liability company (“LLC”) had standing to commence a lawsuit directly against fellow LLC members.  In reaching its conclusion, the Court synthesized nearly fifty years of inconsistent Florida case law bringing clarity to which actions must be maintained directly and which actions must be brought derivatively.

Direct Claim vs. Derivative Claim

But first, it’s important to understand the basic distinctions between direct and derivative claims.  Generally, a derivative action is “an action in which a stockholder seeks to sustain in his own name a right of action existing in the corporation. The corporation is the real party in interest, the stockholder being only a nominal plaintiff.” James Talcott, Inc., v. McDowell, 148 So. 2d 36, 37 (Fla. 3d DCA 1962). A derivative action “must allege two distinct wrongs: the act whereby the corporation was caused to suffer damage, and a wrongful refusal by the corporation to seek redress for such act.” Id. at 38.  See also Kaplus v. First Cont’l Corp., 711 So. 2d 108, 110 (Fla. 3d DCA 1998) (“In a derivative action, a stockholder seeks to sustain in his or her name, a right of action belonging to the corporation.”).  Both the Florida Business Corporation Act and Florida Revised Limited Liability Company Act contain provisions for derivative actions.  See Fla. Stat. §607.07401 (shareholder derivative actions) and Fla. Stat. §605.0801-605.0806 (member derivative actions).See also Florida Limited Liability Company Act, specifically, Fla. Stat. §608.60, for derivative actions in LLCs formed before January 1, 2014.  However, effective January 1, 2015 all LLCs will be governed by the Revised Limited Liability Company Act. Comparatively, a direct action (a/k/a an “individual action”) is a suit by a shareholder/member to enforce a right of action existing in him, separate and distinct from that sustained by other shareholders/members. Citizens National Bank of St. Petersburg v. Peters, 175 So. 2d 54, 56 (Fla. 2d DCA 1965).

A significant distinction between a derivative and a direct lawsuit is one that ultimately impacts the bottom line.  In a derivative action, all recoveries belong to the corporate entity. In a direct action, all recoveries belong to the individual shareholder/member plaintiff(s). That said, aggrieved shareholders/members typically prefer to initiate direct actions and pocket the recovery. However, as clarified by Dinuro, the bar to initiate a direct lawsuit has now been raised.

The Dinuro Facts

In Dinuro, three equal members of San Remo Homes, LLC (“San Remo”) obtained financing to purchase pieces of real estate through subsidiary entities. Due to a decline in the housing market San Remo was forced to negotiate a loan modification with its lender. A term of the revised loan agreement required the three members to make additional contributions to San Remo. Two members made the contributions, while one member, Dinuro, did not. Further, the two compliant members refused to front Dinuro’s member contribution. Consequently, the loan went into default.

The two compliant members formed a new corporation, SR Acquisitions, LLC, and successfully negotiated a purchase of San Remo’s defaulted loan from the lender. Thereafter, SR Acquisitions, LLC initiated foreclosure proceedings against San Remo, acquired the San Remo properties, and left San Remo with no viable assets. Dinuro initiated a direct member lawsuit against the two other members and the lender alleging a breach of operating agreements, tortious interference, and conspiracy to cause the damage outlined in previous counts.

The Defendants moved to dismiss on several grounds, including Dinuro’s lack of standing.  The trial court granted the motion to dismiss “finding that Dinuro lacked individual standing to bring a direct claim against the other members for this type of harm, and that its claims should have been brought derivatively on behalf of San Remo.”

The Third District Court of Appeal agreed with the trial court and provided a detailed opinion to “provide clarity on a complicated point of law.”

Florida’s New Two-Prong Approach

Pulling from “scholarly literature and case law from around the country,” including Florida, the Dinuro Court stated as follows:

[t]he only way to reconcile nearly fifty years of apparently divergent case law on this point is by holding that an action may be brought directly only if (1) there is a direct harm to the shareholder or member such that the alleged injury does not flow subsequently from an initial harm to the company and(2) there is a special injury to the shareholder or member that is separate and distinct from those sustained by the other shareholders or members.

(Emphasis added).

The Court also identified an exception to the rule stating that a “shareholder or member need not satisfy this two-prong test when there is a separate duty owed by the defendant(s) to the individual plaintiff under contractual or statutory mandates.”

Succinctly, if a plaintiff cannot satisfy the two-prong test (direct harm and special injury) or demonstrate a contractual or statutory exception, the plaintiff will have to bring his or her claims derivatively on behalf of the corporation or company.  Relying on this new approach, the Dinuro Court reached the same conclusion as the trial court, that is, Dinuro’s claims could only be maintained derivatively because it was the entity that was initially injured, not the individual.

The attorneys at Fuerst Ittleman David & Joseph, PL will monitor subsequent application of Dinuro.  Our attorneys have extensive experience in the areas of complex corporate litigation, business litigation, tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  If you have any questions, an attorney can be reached by emailing us at contact@fuerstlaw.com or by calling 305.350.5690.

 

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