Dwolla Account Seizure Reveals Mt Gox on Brink of US Indictment

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The US District of Maryland seizure warrant that stopped Dwolla in its tracks this week reveals in good detail that the Department of Homeland Security, the US federal agency charged with not only protecting the US borders but also deterring cybercrime, has been investigating Mt Gox for a while now, and has found a criminal violation to the US federal prohibition to operate an unlicensed money transmission business.

This warrant, which was published yesterday by multiple blogs, officially confirms that the FinCEN guidance of March 18, in which this federal government agency equates virtual currency exchanges and administrators to money transmitters, is already being enforced.  To my knowledge, no charges have been made at this point, but the fact that two bank accounts were seized (see below) seems to indicate that an indictment may be imminent.

What exactly is the “Dwolla Account” seizure warrant that stopped its operations this week?  Why was it issued?  What’s going on here!?

This can get a bit complicated, but I’ll do my best to break it all down in easy bits for you.  Experts, please forgive any imprecision.  I just want to dissect this and boil it down to the wire frames, so most readers can understand it.

Why Mt Gox and Dwolla Need Each Other

If you’re reading this, you know who Mt Gox and Dwolla are, but let me just briefly explain the processes of buying or selling bitcoin through them.  Based in Tokyo, Japan, Mt Gox is currently the world’s largest bitcoin exchange.  If you are in the United States and you want to purchase bitcoin from them, you need a way to get your USD (US dollars) to Mt Gox, so that Mt Gox can send to you the equivalent in BTC (bitcoin).  If you hold BTC and want to sell them, the process is inverted –you send Mt Gox your BTN, and they send you the equivalent USD at the time of the transaction.  Mt Gox makes money by exploiting the difference between the bid and ask rates.

Simply enough, right?  However, the processing of currency exchange transactions requires multiple bank accounts in multiple jurisdictions, so things can get complicated, especially because Mt Gox is also a wholesale exchange.  That is, it allows customer-facing brands everywhere in the world to use its platform, in what is called white or private label arrangements.  Dwolla is one of many online customer-facing brands acting as a payments processor –brokering, if you will, the access of end consumers to Mt Gox’s bitcoins.  In a nutshell, the online brands provide you with an entry point for your dollars, but it’s Mt Gox that provides you the crypto-currency.

If you want more details about how accounts are used, the affidavit that follows this warrant does a good job of explaining the flow of funds.

Are you with me so far?  Let’s now talk about what you came here for, starting with the key participants.

The Players

• Michael T. McFarland, Special Agent, United States Homeland Security Investigations
• Honorable Susan K. Gauvey, United States Magistrate Judge of the US District Court of Maryland
• Dwolla, according to themselves, “a payment network that allows any business or person to send, request and accept money.”  [According to US regulation, a money transmitter.]
• Veridian Credit Union, the financial institution behind Dwolla, which is the custodian of all customer funds, provides them with a professional financial management operation, and may exempt them from having to obtain state money transmitter licenses.  I say may because not all credit unions are created equal, and I cannot confirm at this point whether that’s the case.
• Mutum Sigillum, LLC, a subsidiary of Mt Gox in the United States, registered in the state of Delaware.
• Wells Fargo account, established in May of 2011 and held by Mutum Sigillum, LLC
• Dwolla account, registered in the name of Mutum Sigillum LLC, and held in custody of Verdian Credit Union
• Mark Karpeles, founder and owner of Mt Gox and Mutum Sigillum, LLC

The Dwolla Account Seizure Warrant

• Agent McFarland, a Homeland Security Investigations special agent, is asking a judge for official permission to seize a Dwolla bank account.  Why would or can he do this?  The US has strong asset seizure powers, especially when a federal financial crime has allegedly been committed, as seems to be the case here.  Asset seizures are preventative measures.  Accounts are frozen or assets cordoned off during the course of investigations so as to actually investigate the property seized, and also to prevent the assets from mysteriously disappearing.
• As you may know, a judge can approve this only if there’s probable cause (a reasonable amount of evidence justifying the suspicion that a crime may have been committed).  Well, after reading the evidence presented by Agent McFarland in his affidavit (explained below), Honorable Susan K. Gauvey has been persuaded that there is probable cause, and therefore granted the warrant.
• The agent can now go to Wells Fargo and tell them to freeze the Dwolla account in question.

Why did the judge grant the warrant?  What facts or evidence convinced the judge that there was probable cause?  Read on.  The meat of this bone is in the affidavit, a sworn statement where the agent lays out the evidence supporting his request for the seizure warrant.

Agent McFarland’s Investigation Findings

• Mt Gox subsidiary in the US Mutum Sigillum, LLC holds a US dollar account with Wells Fargo whose only authorized signer is Mark Karpeles, the founder and owner of Mt Gox.
• When Mr. Karpeles opened that account in 2011 he represented to the bank that he was NOT going to be using that account for money transmission.  Clearly, like Mr. Douglas Jackson, founder of E-Gold, he seems not to have been aware that he was in the business of transmitting money!
• The Wells Fargo account was recently subject to an official search (again, authorized by a judge who saw the probable cause), and as a result it was found that the account received wires from Japan’s Mt Gox account that were then disbursed to Dwolla’s bank account (the one that the agent now wants to seize!).  This WF account was seized a few days before the Dwolla account seizure warrant was issued.
• By means of bank records showing transfers between the Wells Fargo account and the Dwolla account, Agent McFarland demonstrated that Mutum Sigillum, LLC is engaged in a money transmitting business although it is not registered with FinCEN.
• Because the Wells Fargo account was involved in this money transmitting activity, its contents are subject to seizure and forfeiture under US law.
• Bank records further indicate that the Wells Fargo account was the sole financial account that was funding the Dwolla account whose seizure the published warrant sought.  Therefore, and I’m going to quote this literally, “it is evident that the Dwolla account was used exclusively to move funds between Mt Gox and Mutum Sigillum and their customers.  Consequently, there is probable cause to believe that Mt Gox and Mutum Sigillum are using [the Dwolla account] to conduct transactions as part of an unlicensed money service business in violation of 18 U.S.C. section 1960, and that the contents of the account are involved in those transactions,” which then justifies its seizure.

Lessons for Bitcoiners

I’ve been talking about the risks of this happening for the past month or so (check out my Virtual Currencies category), and, uncannily enough, this past weekend I wrote about the parallels between E-Gold and crypto-currencies.   In this article, I explain how E-Gold, a virtual currency remarkably similar to bitcoin and its crypto-brethren, practically vanished as a result of an indictment that involved, among others, an “operating of unlicensed money transmitting business” charge.

Here are a few takeaways from this latest development:

• As suggested by the affidavit, the moment a US person (physical or legal) gets involved, that immediately will trigger the jurisdiction (literally, power to tell the law) of the United States, wherever the Bitcoin operator may be in the world.
• Federal agents use all kinds of resources to gather evidence and build their cases, including paid informants, undercover agents, and entrapment (google each of those for details).
• All of the funds involved in an alleged illegal activity are subject to seizure and forfeiture, whose effect, as we could see this week in the Dwolla case (and for a different reason, in the Bitfloor case a couple of weeks ago), can be extremely disruptive, if not permanently crippling.
• In the US, at least, you cannot allege ignorance of the law, so the more you know about rules and regs, the more you’ll be able to avert disaster.  Remember grandma’s advice: “An ounce of prevention…. “
• Remember that exchanging or administering bitcoin or any other crypto-currency is considered money transmission by US regulation, and being a money transmitter carries a heavy compliance burden, including the obligation to obtain money transmitter licenses, especially in the states of New York and Texas.

Bank accounts seized, operations disrupted, expensive lawyers hired, reputations tarnished –just a few of the effects of ignoring US regulation.  It’s always up to each of us how much risk we dare to stomach.  I vote for preventing rather than cleaning up the mess.  In any case, as I’ve said before, the key is to smartly embed the controls into the operation so that the customer interface is seamless, compliant and sticky at the same time.

Will Mt Gox be the next E-Gold, or will things play out differently for the industry this time?