IRS Seeks Leave from Court to Serve Sweeping Summons on Bitcoin Exchange

In an ex parte Application for Leave to Serve John Doe Summonses dated November 17, 2016, the Internal Revenue Service requested of the United States District Court for the Northern District of California the authority to obtain the records of Coinbase, Inc. a bitcoin exchange located in San Francisco.

By its own terms, the request is speculative, relying on an undefined “likelihood” that the resulting summons will yield information identifying persons who have not properly filed or paid taxes due the United States. The only defined term upon which the request is based is IRS Notice 2014-21, which described the Services views on virtual currencies and offered the position that bitcoin (and similar devices) are not “currency” but, rather, are property under 26 U.S.C. §1221. Although the Notice reached this conclusion without analysis or authority, it is probably correct, at least for the moment. Only because bitcoins neither circulate nor are they customarily used and accepted as money in the country in which they are issued, they do not meet the definition of currency in the Bank Secrecy Act. 31 CFR 1010.100(m). Presumably, Treasury adopts this definition for tax purposes.

The request has alarmed the cryptocurrency community because it comes in the wake of absolutely nothing. No criminal case, claims of interviews with only three taxpayers who said they has used virtual currencies as a means of evading taxes, and not even a named suspect in the summons request. The report of the Treasury Inspector General for Tax Administration dated September 21, 2016 observes three critical issues:

  1. The IRS has no strategy concerning virtual currency;
  2. The Criminal Investigation unit of the IRS has undertaken no effort to inquire in matters concerning the improper reporting of bitcoin; and
  3. Notice 2014-21, so far the IRS’s only formal articulation of its position regarding bitcoin, characterizes bitcoin as property, not as currency, although the device is commonly accepted as currency by over 100 major organizations including Subway, Microsoft, Reddit, and Expedia. Many users of bitcoin are likely unaware of the Notice or uncertain of its arcane meaning.

Thus, for the IRS to use as its opening salvo into the matter of virtual currency what is described by its target as a “sweeping fishing expedition” gives every participant in a cutting edge technology pause to consider if the IRS should be able to leverage that enterprise to make up ground in its own investigative dilemmas. In short, should Coinbase become an involuntary source of data for the government absent more evidence supporting a wholesale compromise of the privacy of their customers’ information?

Pastore & Dailey adds Cybersecurity Authority as Partner

Pastore & Dailey is pleased to announce the addition of John R. (“Jack”) Hewitt as Partner in the Firm.  Mr. Hewitt is recognized as one of the nations leading attorneys in cyber law and cyber security compliance issues.  He has advised firms on their development of information security programs and has guided them through cyber incidents and regulatory inquiries.  Mr. Hewitt regularly conducts cybersecurity audits for broker-dealers and investment advisers, and was the SEC appointed independent outside consultant in the first major SEC cybersecurity enforcement action.  Mr. Hewitt brings to the Firm his extensive experience in securities regulation including his tenure as an Ohio Assistant Attorney General and senior prosecutor for the Ohio Division of Securities, followed by his role as a Senior Counsel in the SEC’s Enforcement Division in Washington, D.C.  Mr. Hewitt has been partner and counsel at several of the country’s top law firms including Mayer Brown LLP, McCarter & English and Kelley Drye & Warren.  Mr. Hewitt’s experience compliment’s Pastore & Dailey’s leading role in the securities and banking field, adding to the roster that includes attorneys recognized as top securities litigators, former Wall Street general counsels, attorneys recognized as leaders in consumer finance litigation, NYSE staff attorneys and the former Secretary of State for Connecticut and U.S. Senate candidate. For more information please view Mr. Hewitt’s full bio.

Enforcement in the Second Circuit of FINRA Pre-Hearing Subpoenas and Discovery Orders

In a Financial Industry Regulatory Authority (“FINRA”) arbitration under either the Consumer or Industry Arbitration Rules, there are two mechanisms for seeking discovery.  For parties and non-parties who are not FINRA members, FINRA Rules 12512 and 13512, authorize an arbitrator to issue a subpoena for production of documents.  For parties and FINRA members, FINRA Rules 12513 and 13513, authorize an arbitrator to issue an arbitration order (not a subpoena) for the production of documents. However it is unlikely that a party seeking enforcement of either the subpoena or the order issued by a FINRA arbitration panel will find relief in the court system. But that doesn’t leave enforcement out of reach.

Parties and Non-Parties who are not FINRA members

FINRA Rules 12512 and 13512 authorize an arbitrator to issue subpoenas for the production of documents. FINRA Rules 12512(a)(1) and 13512(a)(1).  If the subpoena is not complied with, the next step for most litigators would be to move to enforce the subpoena in Federal District Court.  However such an action is unlikely to be successful.

There is split among the Circuits but the Second Circuit interprets the Federal Arbitration Act (“FAA”) Section 7 as prohibiting enforcement of subpoenas for pre-hearing discovery.  See Life Receivables Trust v. Syndicate 102 at Lloyd’s of London, 549 F.3d 210, 212 (2d Cir. 2008).  However the Second Circuit court made it clear that,

[i]nterpreting section 7 according to its plain meaning “does not leave arbitrators powerless” to order the production of documents. Hay Group v. E.B.S. Acquisition Corp., 360 F.3d 404, 413 (3d Cir. 2004) (Chertoff, J., concurring). On the contrary, arbitrators may, consistent with section 7, order “any person” to produce documents so long as that person is called as a witness at a hearing. 9 U.S.C. § 7. Peachtree concedes as much, admitting that “Syndicate 102 could obtain access to the requested documents by having the arbitration panel subpoena Peachtree to appear before the panel and produce the documents.” In Stolt-Nielsen, we held that arbitral section 7 authority is not limited to witnesses at merits hearings, but extends to hearings covering a variety of preliminary matters. 430 F.3d at 577-79. As then-Judge Chertoff noted in his concurring opinion in Hay Group, the inconvenience of making a personal appearance may cause the testifying witness to “deliver the documents and waive presence.” 360 F.3d at 413 (Chertoff, J., concurring). Arbitrators also “have the power to compel a third-party witness to appear with documents before a single arbitrator, who can then adjourn the proceedings.” Id. at 413. Section 7’s presence requirement, however, forces the party seeking the non-party discovery — and the arbitrators authorizing it — to consider whether production is truly necessary. See id. at 414. Separately, we note that where the non-party to the arbitration is a party to the arbitration agreement, there may be instances where formal joinder is appropriate, enabling arbitrators to exercise their contractual jurisdiction over parties before them. In sum, arbitrators possess a variety of tools to compel discovery from non-parties. However, those relying on section 7 of the FAA must do so according to its plain text, which requires that documents be produced by a testifying witness.

Life Receivables Trust v. Syndicate 102 at Lloyd’s of London, 549 F.3d 210, 218, (2d Cir. N.Y. 2008).  To obtain the aid of the Court system, the Second Circuit quoting from the Third Circuit clearly indicates that the arbitrators must order an appearance in some fashion of the object of the subpoena.  Accordingly if such an appearance is ordered, then Section 7 of the FAA is no longer a prohibition against the production of the documents even if it is a pre-hearing appearance.

Parties and FINRA Members

FINRA Rules 12513 and 13513 authorize an arbitrator to issue a discovery order for the production of documents.  If the discovery order is not complied with there is no opportunity to turn to the court system for enforcement relief because there was no actual subpoena issued.  However, turning to FINRA’s Department of Enforcement is likely to be successful.

Enforcement of a pre-hearing discovery order, issued to a non-party FINRA member under FINRA rule 13513, is largely an issue of first impression. By way of background, FINRA Rule 13513 went into effect in its current form on February 18, 2013.  Since that time there does not appear to have been any enforcement action by the FINRA Department of Enforcement for its violation.  However, there is at least one enforcement action for violation of a party’s discovery obligations in an arbitration proceeding.  See In Re Westrock Advisors.  It is a violation of FINRA Rule IM-13000 to fail to comply with any rule of the arbitration code and specifically for failure to produce a document:

It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member or a person associated with a member to:

… (c) fail to appear or to produce any document in his possession or control as directed pursuant to provisions of the Code;…

In Westrock Advisors failure to comply with discovery orders was censured and a $50,000 fine was imposed.

Accordingly, enforcement of a subpoena or discovery order without use of the Court system is both possible and likely to be successful in obtaining documents in pre-hearing discovery from parties, non-parties, FINRA members and Non-FINRA members alike.

P&D Joins Professional Service Firm IR Global

Pastore & Dailey LLC is a recently accepted member of IR Global as a Capital Markets Firm for New York and Connecticut.  IR Global is the fastest growing professional service firm network in the world, providing legal, accountancy and financial advice to companies and individuals across 150 jurisdictions.  Each Firm, passing a stringent vetting process upon joining and recommended exclusively by jurisdiction and area of practice.  Pastore & Dailey LLC was announced as new members of the IR Global Group in their latest newsletter.