Fines for Fintech Compliance Violations Are Increasing. So Are Illegal Activities.
Plus, could autonomous AI agents soon be doing your crypto transactions and paying bills on-chain? Maybe.
Number of the Week: $24 million (explanation below)
Fines for Fintech Compliance Violations Are Increasing. So Are Illegal Activities.
Gretchen Morgenson is nobody’s fool. The exclusive story that she broke last week for NBC News about federal prosecutors examining financial transactions at Block and alleged widespread compliance lapses at its Square and Cash App subsidiaries was met with barely a shrug in the market.
Internal documents provided by a former employee to prosecutors from the Southern District of New York and reviewed by NBC News reportedly show crypto transactions for terrorist groups and transactions involving nations subject to U.S. sanctions—Cuba, Iran, Russia and Venezuela—were processed by Block and Square, respectively. Most of the transactions involved credit cards, dollar transfers and bitcoin and were not reported to the government as required. Further, they did not compel Block executives to correct internal processes to prevent such transactions once they were notified of the breaches. “From the ground up, everything in the compliance section was flawed. It is led by people who should not be in charge of a regulated compliance program,” said the former employee, who was granted anonymity by NBC News.
This comes on the heels of a February report that two other whistleblowers alleged inadequate due diligence to establish the true identity of Cash App customers, which poses an accessibility threat conducive to money laundering, terrorism financing and other illegal activities. In the current incident, Block officials told NBC News that “it believed it had voluntarily reported the ‘thousands of transactions’ described by the former employee to the Office of Foreign Assets Control,” the U.S. Treasury department responsible for enforcing economic sanctions. (The former employee contends otherwise.)
The alleged know-your-customer (KYC) and other compliance failings at Block aren’t an isolated incident in fintech, of course, but it begs the question: Is this the price of advancing digital financial innovation? It’s complicated, particularly given the appetite and aptitude of bad actors to exploit new technologies to their criminal, financial or geopolitical advantage. A short list of recent alleged compliance failings at crypto and payment companies underscores the prevalence of those seeking innovative, anonymous or easy ways to launder money, finance terrorism and fund illegal activities. But it also points to the reluctance of fintech CEOs to proactively respond to threats or abide by federal and state compliance requirements to protect the integrity of the U.S. financial system, either because of lax compliance and internal controls or profit motives—or both.
In November, Binance settled charges that it “enabled a range of illicit actors to transact freely” on the crypto exchange by violating U.S. anti-money laundering (AML) and sanctions laws, including failure to implement programs to prevent and report suspicious transactions with terrorists, ransomware attackers, money launderers and other criminals, as well as matching trades between U.S. users and those in sanctioned jurisdictions (Iran, North Korea, Syria, etc.). Binance agreed to a $4.3 billion settlement, the largest in history. It will pay a civil penalty of $3.4 billion to the Financial Crimes Enforcement Network, undergo a five-year monitorship, and a significant overhaul of its compliance system, as well as pay $968 million to the Office of Foreign Assets Control (OFAC) and abide by rigorous sanctions compliance obligations. (Last week, ex-Binance CEO Changpeng Zhao was sentenced to four months in prison.)
In March, crypto exchange KuCoin and two of its founders were criminally charged by the Southern District of New York with Bank Secrecy Act and unlicensed money transmission violations. Specifically, KuCoin was cited for its failure to implement basic anti-money laundering policies, essentially becoming “a haven for illicit money laundering.” The indictment indicates that KuCoin received more than $5 billion and sent over $4 billion of suspicious and criminal funds.
The crypto industry is rife with federal and state charges against companies for violating AML and sanctions requirements, most of which have resulted in monetary settlements and tighter restrictions on operations: Coinbase paid $50 million to New York state and agreed to invest $50 million to improve its AML and sanctions compliance program, Poloniex paid more than $7.5 million in a settlement with OFAC, BitPay paid $1 million in a settlement with the New York Department of Financial Services, and bZeroX, which later became the now-defunct Ooki DAO, paid a $250,000 civil penalty to the Commodity Futures Trading Commission, among others.
It's not just crypto companies, money laundering and terrorist financing. In early April, for example, The Bear Cave, a Substack newsletter written by Edwin Dorsey, alleged that Marqeta, a cloud-based open API card-issuing and payments processing platform, is in “distress” because of its partnerships with Block and Cash App. Dorsey—Edwin, no relation to Jack Dorsey, the CEO of Block—contends that Marqeta is facilitating criminal payments for the purchase of child pornography via a master services agreement it has with Block that includes handling payments for Cash App. (Block is Marqeta’s largest customer, accounting for 68% of its revenue in 2023.) In January 2024, the Southern District of New York charged Kyle White, the operator of The Ho Zone, with advertisement, receipt and online distribution of child pornography. The complaint filed by prosecutors includes screenshots of the site’s payment page, which shows that White was steering users of the child pornography site to pay via Cash App. It should be noted that no charges have been filed against Marqeta, Block or Cash App in this case, though Cash App has earned a reputation as a preferred payment method for sex traffickers.
This week, SoFi’s Money unit was fined $1.1 million by the Financial Industry Regulatory Authority (FINRA) for alleged consumer identification failings in its cash management brokerage service that allowed hackers to make off with about $2.5 million in funds.
In 2023, crypto and fintech companies were fined $5.8 billion for a variety of KYC, AML, sanctions and other compliance failures that encouraged the movement of illicit money around the globe (Binance’s $4.3 billion fine accounted for a majority of the total). The number of fines against crypto and payment companies rose last year: Crypto companies were hit with 11 fines, and payments companies received 27 fines, well above the average each year for the prior five years (less than two annually for crypto companies and five for payments companies). For perspective, traditional banks and financial services companies were fined $835 million last year, the lowest figure in a decade, according to the Financial Times analysis.
The State of Compliance Benchmark Report 2023 found that 60% of surveyed fintechs reported paying at least $250,000 in compliance fines, with one-third paying more than $500,000. The report also found that larger fintechs were more likely to report higher compliance fines—37% of fintechs with 1,000+ employees reported paying over $500,000 in compliance fines the previous year. More than half (55%) of fintechs said that a lack of automation is their biggest barrier to meeting Bank Secrecy Act requirements, and 84% are using or exploring artificial intelligence/machine learning to help them meet compliance requirements.
Certainly, there’s a demarcation between pushing the bounds of innovation—for business profit, economic growth and societal good—and simply slacking off on internal controls or skirting compliance with AML and sanctions requirements. As federal and state agencies step up enforcement efforts, it’s becoming clearer that fintech CEOs will have less room to negotiate the balance of financial innovation and the inclusion that it fosters with their obligation to prevent illicit financial flows and the funding of illegal activities.
Noted & Noteworthy
Mark this down: Over the next five to 10 years, autonomous artificial intelligence (AI) agents will be conducting crypto transactions, paying bills and managing other aspects of people’s financial lives, and answering emails—on-chain and natively. So says Arif Khan, CEO of Alethea AI, which aims to use AI and blockchain technologies “to enable democratic and decentralized ownership of AI,” in a recent interview with Consensus Magazine. Khan’s lofty ambitions and eye-catching projections are nothing new. For the former CMO of SingularityNET, a platform whose open and decentralized network of AI services are accessible through the blockchain, there’s no question that decentralized AI is the future—and he’s doing whatever he can to make that a reality. Through Alethea AI, Khan hopes to combine the Web3 and generative AI worlds, creating an AI protocol that allows generative assets, such as an AI character or AI agent, to be owned, tracked and monetized. Asked to name “promising” open source projects in crypto and AI outside of what Alethea and SingularityNET are working on, Khan offered two: Morpheus, which is facilitating a peer-to-peer network for personal general purpose AI (or smart agents), and Bittensor, whose focus is on the production, marketing and selling of digital commodities—think compute, data, storage, predictions and models—which are then transformed into intelligence, in turn allowing for more efficient, less costly innovation that advances decentralized ownership.
Same crypto-is-a-security argument, different day. The U.S. Securities and Exchange Commission (SEC) served Robinhood Crypto, part of Robinhood Markets, with a Wells Notice last week. The intent of the notice is to alert the company that the SEC is considering—signaling, really—enforcement action against its crypto division for possible securities violations. Robinhood, which offers trading for 15 crypto assets, joins a growing list of SEC targets, including Coinbase, Binance, Kraken, Uniswap and others. “We firmly believe that the assets listed on our platform are not securities, and we look forward to engaging with the SEC to make clear just how weak any case against Robinhood Crypto would be on both the facts and the law,” said Robinhood Markets’ Dan Gallagher, chief legal, compliance and corporate affairs officer, in a statement following receipt of the notice. In a research report issued on Monday, KBW analysts predict that Robinhood will likely “fight the SEC in court and has a higher likelihood to prevail than most U.S. competitors (if put in similar situations) given HOOD’s stricter listings standards.”
U.S. News & World Report is out with its 2024 Best States ranking, which also breaks out the best states for venture capital. To arrive at this, it evaluates the amount of venture capital dollars invested in each state, relative to $1,000 of the state’s nominal gross domestic product. (Venture capital data is from the PitchBook-NVCA Venture Monitor; gross domestic product data is from the U.S. Bureau of Economic Analysis.) This year’s top 10 states for venture funding are Massachusetts (also ranked #1 in business environment, #8 in economy and #10 in best states overall), California (also ranked #2 in business environment), Delaware (also ranked #3 in business environment), New York, Colorado (also ranked #4 in business environment and #4 in economy), Nevada (also ranked #5 in economy and #6 in business environment), Washington (also ranked #7 in business environment), Vermont (also ranked #7 in best states overall), Utah (also ranked #1 in best states overall and #3 in economy) and Maryland.
Seen and Heard…
Proponents of stablecoin as a revolutionary payment instrument face a sobering, near-term reality: A recent study conducted by Visa and Allium Labs found that 90% of stablecoin transaction volume is initiated by bots and large-scale traders, not real people. Out of roughly $2.2 trillion in total stablecoin transactions in April, only $149 billion originated from “organic” payments activity. …Venture firms are sinking more money into climate risk startups—for good reason. Parametric insurance startup Arbol recently closed $60 million in Series B funding co-led by Giant Ventures and Opera Tech Ventures. Similarly, AiDash secured $58.5 million in Series C funding, led by Lightrock and joined by several strategic backers. …Layoffs continue to hit the fintech sector. Last week, insurtechs Sproutt and Assurance were shuttered. Assurance, which was acquired by Prudential Financial in 2019 for $2.35 billion, laid off all 112 workers; the total workforce affected by Sproutt’s closure is unclear, according to the Crunchbase Tech Layoffs Tracker. …MicroStrategy executive chairman Michael Saylor may not have the inside track on SEC goings-on, but if he’s right that the agency is going to rule Ethereum is a security—an unregistered one, at that—by this summer, then the same fate will likely confront Binance Coin, Solana, Ripple and Cardano. Naturally, it also means that all spot Ethereum exchange-traded fund (ETF) applications are a no-go. At MicroStrategy World 2024, Saylor bluntly said: “None of them will ever be wrapped by a spot ETF. None of them will be accepted by Wall Street. None of them will be accepted by mainstream institutional investors as crypto assets.” That puts Saylor and MicroStrategy in an interesting position; both his personal and the company’s bitcoin holdings are significant. Currently, MicroStrategy's 214,400 bitcoins were valued at more than $13.6 billion. Saylor holds more than 17,000 bitcoins and has a 12% stake in MicroStrategy.
FINvestments
🦈 Number of the Week: Block CEO Jack Dorsey is nothing if not a guy who likes to place bets. Add this to his list: In April, the payments company began using 10% of its monthly bitcoin-related gross profit to buy more bitcoin, which it reportedly plans to continue for the rest of the year. Its first-quarter earnings results show that Block had $80 million in bitcoin gross profit; were that level of profit to continue for the balance of 2024, CoinDesk posits, Dorsey would add $24 million worth of bitcoin to Block’s balance sheet through the dollar-cost averaging program. Block purchased 8,027 bitcoins between 2020 and 2021, which are now worth roughly $4.7 billion.
🦈 London-based Eleos, an embedded life and income protection insurance platform founded in 2022, has secured US$4 million in seed funding to accelerate its transformation of the U.K. insurance industry and expand into the U.S. market. This latest round, led by Fuel Ventures and Indico Capital, comes six months after its €700,000 (US$754,000) pre-seed round. In the U.K., 35% of consumers have life insurance, while 6% have income protection insurance. At present, Eleos serves two customer segments in the U.K.: financial companies, which can use its proprietary B2B2C product either as an API or a white-labeled insurance solution, and consumers, who can access life and income protection insurance policies, as well as 24/7 phone or video general practitioner services via a partnership with the Doctor Care Anywhere platform, mental well-being programs accredited by the National Institute for Health and Care Excellence, and 20% off “Anytime” membership at Nuffield Health gyms, among other benefits. As it works to expand in the U.S., the insurance market looks different than that of the U.K.: 52% of Americans have some life insurance, according to LIMRA and Life Happens’ recent Insurance Barometer Study. An estimated 51% of American workers have disability insurance (also known as income insurance), but the number of people who have income protection policies is down 12% from 2018 and 18% from 2013. Eleos expects to generate more £1 million (US$1.25 million) in revenue by year end.
In Case You Missed These FIN Reads…
Ex-Binance CEO Changpeng Zhao is sentenced to four months in prison. In the run up to the judge’s sentencing, Zhao gave a master class in how to beat the system.
Revolut nabs a Mexican banking license and aims to capture part of the projected $88 billion in remittance flows. Plus, what the Federal Trade Commission’s noncompete ban means for fintech innovation hubs like New York.
Parametric insurtechs could be the future. Insurers’ relationship with fossil fuel companies and projects is why these insurtechs are poised for big growth “triggered” by climate events.
Tally abandoned its B2C credit card payoff app. Will the pivot to a B2B model boost its business? See what led to Tally’s decision and what it faces ahead here.
Bloomberg News Investigative Reporter Zeke Faux goes off on the crypto industry going nowhere good. Listen to the author of “Number Go Up: Inside Crypto’s Wild Rise and Staggering Fall” give his reasons why on FIN’s Fast Forward podcast here.
Follow FIN: The Fast Forward on Fintech on LinkedIn here and X (aka Twitter) here.