Criminal and Civil Forfeitures Involving Cryptocurrency: An Introduction to Federal Forfeiture Processes

By Anthony Diosdi

Jorod Koopman, director of cybercrime at the Internal Revenue Service (“IRS”), recently shared some information regarding cryptocurrencies seized by the government with CNBC. Jorod Koopman’s division handles crypto tracing, investigating tax evasion, filing false tax returns, and money laundering. The cybercrime unit of the IRS works with the Federal Bureau of Investigation (“FBI”), Homeland Securities Investigations (“HSI”), the Secret Service, and the Drug Enforcement Agency (“DEA”) to seize cryptocurrencies.

According to the director, the government seized $700,000 worth of cryptocurrency. In 2020, it was up to $137 million. As of August of 2021, the government has seized over $1.2 billion in cryptocurrency. Interviews with current and former federal agents and prosecutors suggest the government has no plans to curb its appetite for cryptocurrency. With seizures of cryptocurrencies likely to increase in the future, there will undoubtedly be legal challenges to the forfeiture of these assets. This article will summarize the procedural requirements for federal forfeitures of property and discuss the legal grounds to contest federal forfeitures in federal court. Although this article will focus on the forfeiture of cryptocurrency, the concepts discussed in this article can be applied to any property seized by the federal government. Consequently, this article uses the terms “cryptocurrency” and “property” interchangeably.

History of the Forfeiture Laws

In order to understand the law governing government seizures or forfeitures, particularly its procedure, it is important to review the history of the law of forfeitures. The law of forfeitures, particularly its procedure, is arcane, reflecting ancient concepts and old admiralty practices. Early American forfeiture laws derived from America’s British heritage. Forfeiture in old England was rooted in the principle of the “deodand,” meaning a thing given to God under religious law because it was used to cause a death. The principle was used primarily for animals causing human death, who were then “forfeited” to the English King or Queen (who stood in for God), and the royal staff sold the animal to give the proceeds to the poor. Often the property owner was permitted to remit the value of the property instead of the animal. This concept of “redemption” became incorporated into English seizure laws, and also of the United States.

The deodand was never incorporated into American law. However, the concept of in rem proceedings against a “thing” for violating the law was incorporated into American customs and admiralty laws governing the seizure of ships for crimes of piracy and smuggling was incorporated into American law. In 1966, these procedures were formalized in the Supplemental Rules for Certain Admiralty and Maritime Claims which apply to U.S. forfeiture cases. Seizures of assets in illegal smuggling cases were processed by an administrative agency such as the U.S. Customs Service. Owners were often allowed to redeem their property. But, they did not have a right to challenge the seizure in court.

In 1970, the Congress passed the Comprehensive Drug Abuse Prevention & Control Act to respond to the “growing menace of drug abuse in the United States.” This law contained criminal forfeiture authority for defendants convicted of conducting a Continuing Criminal Enterprise (“CCE”), 21 U.S.C. Section 848, as well as civil in rem forfeiture authority contained in the U.S. customs laws, which by that time provide an opportunity for property owners to contest the forfeiture in court by filing a claim and cost bond with the seizing agency. In 1982, a criminal forfeiture provision was enacted as part of the Racketeering Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. Section 1961, which provided for the forfeiture of all property over which the RICO organization exercised an influence. In 1984, Congress enacted 21 U.S.C. Section 853 as part of the Comprehensive Forfeiture Act, and provided for forfeiture of all direct and indirect proceeds and instrumentalities of drug trafficking upon the conviction of any felony drug offense. In 1986, the Money Laundering Control Act added civil and criminal forfeiture provisions at 18 U.S.C. Sections 981 and 982 for confiscating property involved in money laundering and structuring transactions.

As the Department of Justice’s use of the forfeiture statutes became more robust, the 2000 Civil Asset Forfeiture Reform Act (“CAFRA”) was enacted. Prior to CAFRA, once a United States Attorney demonstrated “probable cause” (i.e., a reasonable ground for belief) that the property was subject to forfeiture, the burden shifted to the owner to establish its legitimacy. That burden was taken away in CAFRA. In addition, under CAFRA liability was imposed on the U.S. government for an owner’s attorney’s fees if the owner successfully litigated a civil forfeiture action and won release of his/her property.

Basics of Forfeiture Procedure

Presently there are two basic procedural approaches to forfeitures in federal court: civil forfeiture and criminal forfeiture. Although the impact and purpose of these two procedures are virtually identical, the mechanics and conceptual approach are quite different.

Administrative Forfeiture

Each year, the majority of federal forfeitures in the U.S. are obtained through administrative forfeiture. Since 1990, the customs laws (19 U.S.C. Section 1607) have permitted administrative forfeiture of currency and monetary instruments without limit, and of other personal property up to a value of $500,000. An administrative forfeiture begins when a federal enforcement agency (i.e., the IRS, HSI, DEA, or FBI) seizes an identified asset such as cryptocurrency during the course of a criminal investigation. The investigation may be a purely federal one, or may be a task force which also involves state enforcement agencies. Once the property is seized, attorneys for the seizing agency are required by CAFRA to send notice to any persons whom the government has reason to believe may have an interest in the property. Such notice must be sent within 60 days of the seizure if a federal agent seized the property. An administrative forfeiture can also be based upon an “adoptive seizure,” where a state or local officer has seized the property under the authority of state or local law, but then transfers it to federal custody for forfeiture. In that case, the federal adopting agency has 90 days after the seizure within which to send notice. The notice is usually sent by certified mail or federal express, so that the agency has proof of delivery. The notice is usually entitled “Notice of Seizure and Information to Claimants CAFRA Form – Currency.” Below, is an example of a “Notice of Seizure:”

NOTICE OF SEIZURE AND INFORMATION TO CLAIMANTS
                                                CARFA FORM – CURRENCY

Mark Jones
3909 North Ocean Blvd
Fort Lauderdale, FL 33308

Re: Case Number 123456789

Dear Mr. Jones:

This is to officially notify you that Homeland Security Investigations (HSI) agents seized the property described below while executing a search warrant on April 15, 2021:

1. 62863.12345 in Rocket Pool (RPL) virtual currency
2. 12345.12345 Uniswap (UNI) virtual currency
3. 123,123.89 Dogecoin (DOGE) virtual currency
4.  978.1235699 Ethereum (ETH) virtual currency

The property was seized and subject to forfeiture under Title 18, United States Code (U.S.C.), Section 981(a)(1)(C)(civil forfeiture), U.S.C. 1956(c)(7)(A)(money laundering), and 21 U.S.C. 841(a)(1)(prohibited acts involving a controlled substance).

In addition to issuing a notice to any person whom the agency has reason to believe may have an interest in the seized property, the agency which seized property must also publish its intent to forfeit for three successive weeks in a newspaper of general circulation in the area where the property was seized, or via a government internet publication website. A person receiving notice has 30 days within which to file a sworn claim with the seizing agency, asking for one of two types of relief: 1) the opportunity to challenge the forfeiture in court; or 2) remission or mitigation or mitigation from the forfeiture. In the second option, the property owner is basically acknowledging the forfeiture, but claiming some mitigating circumstances. If a timely claim is filed under the first option, the seizing agency refers the matter to the appropriate U.S. Attorney’s Office to file a judicial forfeiture action in the case.

Let’s assume that a government agency has taken cryptocurrency from a claimant’s wallet or the wallet of another individual and the claimant has a financial interest in the seized virtual currency. How should the claimant proceed? The first question anyone whose property was seized by a federal law enforcement agency should ask is there a legal basis to challenge the seizure. This requires an understanding of forfeiture law.  Forfeitures are typically broken down into three categories discussed below.

1. Contraband

The first category of properties subject to forfeiture is property that can be classified as contraband. The concept of a forfeiture of contraband is succinctly summarized by David Pimentel, in Forfeiture in Federal Court: An Overview, 183 F.R.D 1, app. At 18-32 (1998):

“The simplest forfeitures, both conceptually and practically, are forfeitures of contraband, that is, property the mere possession of which is illegal. Justification for this type of forfeiture is self-evident: because the law prohibits the individual from possessing the property in the first place, forfeiture is an essential element of the remedy. This is particularly true when the contraband is a threat to public health or morale – e.g., obscene material, sawed-off shotguns, adulterated food, or illegal drugs. Seizure of these materials serves the important function of removing them from public circulation where they may do damage. Because there can be no legitimate claim to such property, procedural rights of “owners” in confiscation proceedings are not a significant concern.”

There is no “innocent-owner” problem with contraband because it is illegal to possess the property in the first place and of course, cryptocurrency is not contraband. Thus, this category of forfeitures will not apply to confiscated virtual currency.

2. Proceed- Foreitable as Unjust Enrichment

The next category of forfeiture is proceeds of a crime. The primary purpose here is to deny a wrongdoer of the benefit of ill-gotten gains. Unlike contraband, there is nothing inherently offensive in the property itself, only in the means by which it was acquired. Consequently, innocent owners of criminal proceeds who gave no value for the forfeitable property will not likely be protected by an innocent owner defense. On the other hand, if an individual is a bona fide purchaser for value of the property seized, the innocent owner’s defense should protect them for whatever “value” that was given for the property. In the case of cryptocurrency, the critical issue that would need to be determined is whether the property is indeed the product of criminal activity. If the cryptocurrency is proceeds of criminal activity, it is subject to confiscation by a federal law enforcement agency. However, even if the virtual currency is proceeds of criminal activity, if the claimant is a bona fide purchaser for value of the cryptocurrency seized, he or she may have a valid defense to the forfeiture. Often cryptocurrencies are purchased through commingled funds in which some of the funds are the proceeds of criminal activity and some of the funds are “clean.” This may require detailed tracing to determine which coin based currency should not be forfeited.      

3. Facilitating Property

The last category of property subject to forfeiture is known as facilitating property. There are four rationales for forfeitures of facilitating property: 1) punishment; 2) deterrence; 3) incentive to greater care; and 4) removal of facilitating property from circulation.

A seizure of an automobile used to pick-up a prostitute in Bennis v. Michigan, 516 U.S. (1996) is an example of this “facilitating property” category. There is nothing inherently wrong with the car (as there is in case of contraband), and there is nothing illegal as to how the vehicle was acquired. The forfeiture was permissible in Bennis because the property was misused. The theory of forfeiture discussed in Bennis can be applied to the seizure of cryptocurrency. Because cryptocurrency is a form of currency or money, it is not too difficult to imagine a scenario in which cryptocurrency is misused. Money laundering is a good example of this “facilitating property” category. Money laundering is the process of changing money obtained from crimes into a legitimate source.

An example of money laundering would be taking large amounts of U.S. currency from drug trafficking and converting the dollars to cryptocurrency. Forfeiture law allows forfeiture of any property which is “involved in” a moneylaudering offense. See 18 U.S.C. Sections 981(a)(1)(A) and 982(a)(1). This concept reaches further than “facilitating” because it allows the government to forfeit untainted property which has been commingled with the criminally-related property. For example, if an individual uses criminally obtained virtual currency to purchase real property in the name of a nominee family member, but half of the purchase price is paid for with legitimate funds, the entire real property may be subject to forfeiture. That is, unless the family member can establish that he or she was a bona fide purchaser for value of the real property.

The primary limitation on the “facilitating property” category is the assertion of the Eighth Amendment defense of “excessive fines and penalties.” The Eighth Amendment to the U.S. Constitution prohibits the government from imposing an excessive fine or penalty. In Austin v. United States, 509 U.S. 602, 622 (1993), the Supreme Court applied the Eighth Amendment to civil forfeiture cases, determining that such forfeitures must be limited to property which is, some way, “proportional” It is important to note that the Eighth  Amendment  analysis applies strictly to forfeitures of facilitating property. Federal courts view the forfeiture of proceeds as precisely calibrated to the gravity of the offense giving rise to the forfeiture. See Stefan D. Cassella, Asset Forfeiture Law in the United States Section 1-5, at 24-25 (2007). Thus, the confiscation of cryptocurrency used in an illegal transaction will likely survive an Eighth Amendment challenge. However, if an enforcement agency seizes virtual currency that is far in excess of the illegal transaction or is unrelated to an illegal transaction, the government seizure of the cryptocurrency may not challenge an Eighth Amendment challenge. 

Factors to Consider Before Filing a Claim

A review of the three categories of forfeitures in cryptocurrency seizure cases provides that there are two main defenses: 1) innocent owner defense and 2) Eighth Amendment challenge. (There may also be procedural defenses which will be discussed below). If a claimant has a defense to the seizure, the second question that must be considered is whether contesting the confiscation of the virtual currency will increase the probability of criminal prosecution.

Anyone that has property confiscated by a law enforcement agency must understand that once a seizure has occurred, it is obvious that the authorities are actively pursuing an investigation, and anyone even tangentially connected with the property at issue has a strong incentive to lie low. Coming forward to contest the forfeiture is certain to attract the attention of, and even antagonize, law enforcement at the precise moment that an individual that had property seized may want to appear uninvolved, cooperative, or both.

Thus, even if a claimant has an innocent owner and/or Eighth Amendment defense, the filing of a claim can potentially compromise his or her rights against self-incrimination. Consider, for example, Sue and Tom, who share a joint bank account and jointly acquire cryptocurrency with the money they have earned legally and saved over the years. Later, Sue is investigated on suspicion of insider trading, although there is no evidence that Tom was ever aware of her inside information or that Sue was acting on it. The government identifies and seizes Sue and Tom’s wallet which contains bitcoin based on evidence that the bitcoin was paid for out of the same account where Sue had deposited the proceeds of her insider trading activity. Sue and Tom’s best defense to the forfeiture may well be that her insider trading activity did not begin until after the bitcoin was purchased. They may have witness testimony, including their own, that could substantiate the date upon which Sue’s involvement in insider trading began.

If the government seizes the bitcoin in a forfeiture, Sue and Tom are unlikely to contest it. The evidence that will clearly vindicate their claim to Bitcoin will simultaneously convict Sue of the underlying offense. Even if Sue and Tom’s evidence does not incriminate them directly, it may well be interpreted as a waiver of some or all of their rights against self-incrimination, opening them up to cross-examination in a subsequent hearing and in any subsequent trial regarding potentially incriminating matters. See Rogers v. United States, 340 U.S. 367, 372-73 (1951).

Section 981(g)(2) of Title 18 attempts to address this problem by allowing a court to stay the forfeiture proceeding upon motion by a claimant, if 1) “the claimant is the subject of a related criminal investigation” and 2) “continuation of the forfeiture proceeding will burden the right of the claimant against self-incrimination” in the criminal proceeding. The statutory provision may provide small comfort, however, for a variety of reasons. First, a claimant, such as Tom, may not be a subject of criminal investigation himself and therefore not entitled to the stay. Second, Tom may be motivated by concerns about incriminating Sue rather than concerns about incriminating himself, so the stay is not necessary to protect Tom’s rights against self-incrimination. See Forfeitures Revisited: Bringing Principle to Practice In Federal Court, David Pimental, Nevada Law Journal, Vol. 13:1 (Fall 2012).

The example of Sue and Tom demonstrates that contesting a forfeiture may involve making certain admissions that may play into the hands of criminal investigators. The Sue and Tom example also demonstrates the need to do a detailed analysis of all the facts and circumstances of each case before filing a claim. In certain cases, the filing of an administrative claim that will ultimately result in litigation is not worth the risk. In these cases, individuals that had property confiscated by an agency may want to consider making an offer to the government. 19 U.S.C. Section 1617 and 19 C.F.R. Sections 161.5, 171.31 authorizes offer in compromises in forfeiture cases. Through an offer in compromise, the property owner is basically acknowledging the forfeiture, but is claiming some mitigating circumstance.

Procedurally, an offer in compromise must be submitted to the seizing agency. An offer in compromise is submitted on the same form used to challenge the forfeiture in court. A request for an offer in compromise must be submitted prior to the forfeiture deadline. The individual that is requesting an offer in compromise must check Box 2 on the “Election of Proceedings” of the notice The amount offered must be submitted to the seizing agency before the forfeiture deadline. An attachment must accompany the offer which states “the offer is being made under the provisions of 19 U.S.C. Section 1617.”  If the offer is rejected, the individual will have an additional 30 days from the date of the decision to file a claim.

Filing the Claim

If it is determined that filing a claim with the seizing agency is appropriate, a timely petition with the seizing federal agency must be filed. Sometimes, a petition must be filed with multiple agencies. The 30 day deadline to file a petition with the agency that seized the property is firm. If a claim is filed after the deadline provided in the notice and publication expiration date, the property seized is summarily forfeited to the United States.

The petition does not need to be in any specific form, but it must describe the property involved, identify the date and place of the seizure, and include the facts and circumstances which warrant relief from forfeiture and include proof of interest in the seized property. Once the seizing agency has received the petition, the agency will likely refer the matter to the appropriate U.S. Attorney’s Office to file a judicial forfeiture action to a United States district court with proper venue to adjudicate the matter.

Civil Judicial Forfeitures

Once the U.S. Attorney’s Office receives a referral from a seizing agency, that office has 90 days to either file a civil judicial case or include the seized asset in a criminal indictment and name it for criminal forfeiture. See 18 U.S.C. Section 983(a)(3)(A). If a civil case is not filed within those 90 days, the CAFRA rules will prevent the United States from ever filing a civil forfeiture case. See 18 U.S.C. Section 983(a)(3)(B).

As discussed above, in a civil forfeiture case, the U.S. Attorney does not have to prove that the individual whose property seized by the government committed or participated in the commission of criminal activity. As long as there is proof that the property is sufficiently linked to a crime, and the owner cannot establish that he or she is an “innocent owner” by a preponderance of the evidence, the property seized will be forfeited. The “innocent owner” definition in the U.S. Code depends upon when the owner acquired an interest in the property. The most common defense in cryptocurrency seizure cases is that the claimant acquired the virtual currency after the crime occurred (for example, proceeds of the crime), he or she must prove by a preponderance of evidence that he or she 1) was a bona fide purchaser for value; and 2) did not know or was reasonably without cause to believe that the property was subject to forfeiture. See 18 U.S.C. Section 983(d)(A). Only a bona fide purchaser for value without notice or knowledge can defeat a civil forfeiture proceeding.

In a civil forfeiture case involving cryptocurrency, a claimant may take one or both approaches to defending a forfeiture: 1) the claimant may challenge the government’s ability to sustain its burden to prove the cryptocurrency has a “nexus” to the crime; and/or 2) the claimant may assert an “innocent owner” status which would deny forfeiture even if the government proves forfeitability. If the claimant asserts the “innocent owner” status, he or she will have the burden to prove that defense by a “preponderance of the evidence.”

Criminal Forfeiture

Forfeitures do not always involve civil cases. A forfeiture may also be bought through a criminal case. Criminal forfeitures are distinct from civil forfeitures in several respects. Because the forfeiture is in personam, only the property of the convicted defendant may be forfeited, not the property of third parties used to facilitate the crime. For example, if a defendant is charged with securities fraud and income tax evasion, and is convicted of the tax evasion charges, but not the fraud offenses, there can be no forfeiture because the law does not provide for forfeiture based upon tax evasion. However, criminal forfeiture laws have added 28 U.S.C. Section 2461(c) which provides that if any law provides for civil forfeiture, then the prosecutor may also include a criminal forfeiture for the property in a criminal indictment. Prosecutors often seek parallel civil and criminal proceedings against the same property.

Criminal forfeiture is in personam, against the defendant. In this type of forfeiture, only property in which the defendant has a true interest may be forfeited criminally. Property which is held by “nominees” or straw owners on behalf of the defendant may be forfeited criminally, but the government must prove that the defendant is the true owner. Any property which is truly owned by other parties who are not convicted as part of the criminal case, such as a spouse or other family member or business partners, may not be forfeited criminally. Such property may be forfeited only in a civil action.

The greatest advantage which criminal forfeiture holds for the government is that it affords the possibility of a money judgment for the amount of the proceeds of the crime, and property involved in the crime. If that property- for example, the direct proceeds obtained by a fraudulent scheme or the real property which was used to store narcotics – is no longer owned by or in the possession of the defendant, the government can get a judgment  against the defendant for an amount equivalent to the value of that property. Rule 32.2 of the Federal Rules of Criminal Procedure permits the government to seek forfeiture of “substitute assets” belonging to the defendant. The procedure for obtaining criminal forfeiture is a bifurcated process. First, the defendant must be found guilty by proof “beyond a reasonable doubt” by a judge or jury. Following the entry of a guilty verdict or guilty plea, the judge or jury will consider whether the government has shown the required “nexus” between the property named for forfeiture and the crime of conviction. If forfeiture is ordered, a Preliminary Order of Forfeiture is entered against the defendant, which becomes final at sentencing.

The Preliminary Order of Forfeiture must be served on anyone whom the prosecutor has reason to believe may have an interest in the property, and must be published unless it is a money judgment alone. Any interests asserted by third parties are heard in a separate part of the criminal case called an “ancillary proceeding,” which is held after a guilty verdict or guilty plea by the defendant. For example, let’s assume from our prior example that Sue is convicted of insider trading and money laundering. Let’s also assume that the government obtains a judgment against Sue. With the exception of a wallet that contains approximately 30,000 Bitcoin in it that she owns jointly with Tom, Sue is insolvent. The prosecution will serve a Preliminary Order of Forfeiture on Tom for the Bitcoin. Tom must now prove by a preponderance of the evidence that he has an interest in the 30,000 Bitcoin which is superior to that of Sue. If Tom is able to establish an interest superior to Sue in the 30,000 Bitcoin, the court must carve out that interest from the final order of forfeiture.

Conclusion

Government asset seizures are not new. As more and more people become involved in virtual currency trading, the government will be following the money and applying new techniques for tracking and seizing cryptocurrency. As the government steps up its seizures of cyropocurreny, more and more innocent virtual currency traders will have their cryptocurrency seized by the government. Whether or not a claim should be filed with the federal law enforcement agency that seizes cryptocurrency should or should not be filed should be carefully considered. If you had virtual currency seized by the government, you should immediately consult with an attorney experienced in handling federal forfeiture cases.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. He has litigated cases in federal courts throughout the country, focusing on tax controversy. Anthony Diosdi has represented clients in federal civil and criminal forfeiture cases. He has also advised clients in matters involving federal law enforcement agency seizure of cryptocurrency.  

Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com. 

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.