Role of Lawyers Seen as Crypto Whistleblowers Emerge

Samuel Bankman-Fried arrives in Manhattan federal court on January 3, 2023 in New York. The FTX founder is accused of defrauding investors and looting customer deposits on his cryptocurrency trading platform. (AP Photo/Seth Wenig)

As pleas from government agencies go, these were emphatic.

“The Whistleblower Office of the Commodity Futures Trading Commission is issuing this notice to inform the public how they can qualify for both financial pricing and certain protections while helping to stop fraud and manipulation related to virtual currencies,” it said a web post. dated May 2019.

The CFTC went on to explain that virtual currencies such as Bitcoin are considered commodities under the Commodity Exchange Act, which triggers the CFTC’s enforcement of the law when a virtual currency is used in a derivative contract, or if there is fraud or manipulation involving a virtual currency. dealt in interstate commerce.

Meanwhile, the Securities and Exchange Commission lists “initial coin offerings and cryptocurrencies” as one of the areas ready and willing to accept the help of whistleblowers to investigate possible violations of the federal securities laws.

The number of whistleblowers responding to calls for crypto-related tips has increased in recent years, according to data compiled by lawyers at Mintz Levin in Boston.

In 2020, the SEC received a total of 6,911 tips, of which only 345 – or 5 percent – ​​were related to cryptocurrency or initial coin offerings. In 2021, the SEC admitted 12,210, and 762 (6.2 percent) traded cryptocurrency or initial coin offerings.

In 2022, the SEC received a similar number of tips (12,322), but 1,719, or 14 percent, related to cryptocurrency or initial coin offerings.

A similar trend was observed with the CFTC, which saw a 50 percent increase in the total number of tips between 2021 and 2022.

“The majority of tips received during the period involved fraudulent embezzlement and fraudulent solicitation involving crypto/digital assets (eg pump-and-dumps, fraudulent representations of

opportunities, or refusal to comply with retraction requests),” the CFTC noted in an annual report on its whistleblower and community education initiatives.

In other words, the “age of the crypto-whistleblower” is upon us, as both the SEC and CFTC have risen to the challenge of bringing some law and order to what has been a largely unregulated digital asset industry. As documented in news reports, the industry has fallen victim to various types of fraud, including price manipulation, exploitation of market players, theft of assets and tax evasion.

To get a sense of how this new area of ​​the law may continue to evolve, Lawyers Weekly spoke with lawyers who may soon find themselves on either side of cases involving crypto-whistleblowers.

Outside looking in

Whistleblowers in other contexts are typically employees or other company insiders whose positions give them unique access to information useful to a government investigation.

But many crypto companies use blockchains—the immutable digital ledger of financial transactions—that are publicly available, potentially expanding the universe of whistleblowers significantly.

“Now anyone with the time, skill and inclination can audit every transaction on a public blockchain, and the concept of the ‘traditional’ whistleblower has greatly expanded in this relatively unregulated space,” Mintz colleagues Cory S. Flashner, Adam L. Sisitsky and Edmund P. Daley writes in an analysis of the trend posted on the firm’s website.

A recent example of such investigative efforts involved Voyager Digital, Daley told Lawyers Weekly.

The centralized financial platform, which had filed for Chapter 11 bankruptcy last July, appeared to be selling assets through crypto exchange Coinbase, online experts determined.

These scouts took the information not to the SEC or CFTC, but to the public via Twitter. But it remains a good example of the kind of detective work that can be done with the right expertise, Daley said.

A small counterweight to the rise in crypto-whistleblowing activity is the “libertarian” attitude and distrust of institutions such as banks or the government that have become caught up in the ethos of segments of the cryptocurrency industry, lawyers acknowledged.

But the increasing number of whistleblowers who come forward suggests that other impulses are carrying the day.

“If you’ve been the victim of fraud, that tends to be a pretty strong motivator that somebody needs to do something about it,” said Robert M. Thomas Jr. from the Whistleblower Collaborative in Boston.

Whistleblowers may also be awarded between 10 and 30 percent of the penalties collected by the SEC or CFTC, if those penalties exceed $1 million.

“The financial incentive is precisely designed to move the needle for people who are hesitant for whatever reason,” Thomas said.

As with other whistleblower awards, to qualify, a whistleblower must be able to demonstrate that the information he has provided to authorities was not obtained solely from public sources such as court hearings, government reports or the media.

At first glance, that might appear to pose a challenge for a whistleblower analyzing a public blockchain, but lawyers agreed that it would not be a major obstacle to recovering damages, largely because of the expertise needed to to analyze the transactions and gain useful insights for the government.

Especially in this context, having the help of a whistleblower will be significantly more effective than using subpoenas or search warrants, Thomas said.

“It’s a huge investigative benefit to have someone who basically gives you a road map and tells you that if you’re looking for a needle in a haystack, you can skip this whole part of the barn,” he said.

The paper by Flashner, Sisitsky and Daley notes that it is an “unsettled question” whether the SEC or the CFTC will emerge as the “leading digital asset regulator.”

The SEC has more resources, and at this point its enforcement efforts seem to appear daily in the Wall Street Journal, Daley said. But the CFTC supports those efforts in a “meaningful” way, he added.

Thomas noted that, given their overlapping jurisdictions, the two agencies in some cases allow potential whistleblowers to file with both and leave it up to them to arrange the investigative work.

None of the attorneys interviewed expects the agencies to be stingy when it comes to rewarding whistleblowers. At least one actually suspects that it will be the opposite.

“I think it’s going to be a strange race to the top among regulatory agencies,” said Boston white-collar defense attorney David G. Lazarus, who noted the high degree of discretion agencies have in deciding what to award whistleblowers. “None of the potential regulatory agencies will want to be seen as stingy.”

That, in turn, could lead to a degree of agency shopping by sophisticated whistleblowers seeking to maximize the potential recovery for their clients, he theorized.

“The agencies are going to want to present these statistics,” Lazarus said.

Challenges ahead

Compared to cases arising under the False Claims Act, the SEC and CFTC whistleblower programs involve a more informal process that does not require the filing of a lawsuit subject to Rule 11’s good faith requirements, said Boston whistleblower attorney Royston H. Delaney.

In fact, the agencies themselves refer to what is sent to them as a “tip,” which doesn’t have to come from lawyers, Delaney said.

However, Delaney explained that certain crypto whistleblowers may find it beneficial to retain an attorney for one specific reason: to maintain their anonymity.

If an award is made to a whistleblower, the agency will need to know “where to mail the check,” which, in the absence of legal assistance, will mean the relator’s name will be made public.

In false claims law, whistleblower attorneys tend to be able to develop relationships within the Justice Department to get regular updates on the status of a case and can manage their clients accordingly, Delaney said.

In contrast, SEC investigations are usually more of a “black box.”

“It can be quite a long process and can be difficult to monitor,” Delaney said.

But the opacity of the situation can also help whistleblowers determine their value, Lazarus suggested.

“It will make any information that may come out that much more valuable,” he said.

While not unique to the crypto context—the same phenomenon exists with cutting-edge technology in healthcare—Thomas predicted there will likely be a learning curve for lawyers when the first crypto whistleblower case comes in the door.

“The biggest challenge for us in terms of intake is that we have to slow down the caller a little bit,” he said. “They can’t assume we’re crypto geeks.”

Expected amount of activity

The explosion of whistleblower tips will inevitably lead to a surge in enforcement actions, with no real end in sight, lawyers said.

Many traditional companies were eager to “ride the wave” of non-fungible tokens — or NFTs — and may have opened themselves up to unforeseen legal difficulties, Daley said.

For example, a judge recently declined to dismiss a proposed class action lawsuit filed by buyers of NBA Top Shot Moments, which are digital video clips of professional basketball highlights. The lawsuit is based on the premise that these NFTs are unregistered securities from which its creators allegedly reaped millions of dollars in profits by preventing buyers from “cashing out.”

In terms of potential whistleblower activity, “the sky’s almost the limit,” Thomas agreed.

Clichés like “the wild west” and “brave new world” have been associated with the crypto space, but the fact that there are two agencies taking on the challenge of regulating the industry “tells you there’s a lot of development ahead,” Delaney said.

Delaney predicted that as crypto whistleblowers begin to reap financial rewards, a “cottage industry” of non-lawyers may begin to grow around it.

Despite the “very methodical” way the SEC and CFTC operate, it may motivate lawyers to specialize in such matters.

“Once they get a reputation, they should get a lot of work,” Delaney said.