12/17/2024

Crypto Fraud Victims Often Shortchanged Due to DOJ Regulation

Bloomberg Law

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Victims of cryptocurrency fraud often lose out to the government when it comes to recovering their losses. That is because of an obscure Department of Justice regulation that prioritizes the government’s right to keep forfeited funds over victims’ rights to restitution for their losses.

Regulation 28 CFR 9.8(c) has a devastating impact on victims. It conflicts with Congress’ goals of ensuring that victims of federal crimes be made whole, and should be changed to ensure that victims, rather than the government, have priority when funds are recovered from a defendant.

Despite the unfairness and prevalent application of the regulation to deny victims their full restitution, it has largely escaped public scrutiny because it is applied by a little-known section within the DOJ as part of an administrative process that isn’t public and is subject to little or no meaningful judicial review.

Few assets have risen in value as quickly and sharply as cryptocurrency. Bitcoin has experienced a 1,245% increase over the past five years, soaring briefly to more than $100,000 over the past few weeks. Ethereum has seen a 2,405% increase over the past five years.

At the same time, fraud is rampant in the cryptocurrency space. Phishing, social engineering, extortion schemes, and SIM swapping—through which fraudsters gain control of a victim’s cell phone and reset the victim’s accounts— are just a few examples of how bad actors defraud victims of valuable crypto assets.

According to the Federal Bureau Investigation’s 2023 cryptocurrency fraud report, the FBI received more than 69,000 complaints from the public regarding financial fraud involving the use of cryptocurrency in 2023. Estimated losses with a nexus to cryptocurrency totaled more than $5.6 billion. Those over age 60 were by far most likely to be victimized by cryptocurrency fraud.

Successfully investigating and prosecuting crypto fraud is rare, and recovering assets in these cases is even rarer. But incredibly, even in that small sliver of cases, the government generally keeps most of the recovered assets at the expense of the victims.

Congress passed the Mandatory Victims Restitution Act in 1996 with the “primary and overarching” purpose “to make victims of crime whole, to fully compensate these victims for their losses and to restore these victims to their original state of well-being.”

For victims of crimes covered by the MVRA, including most crypto fraud offenses, the amount of restitution is provided by a basic and sensible formula (assuming the stolen property itself can no longer be returned). That is, the greater of the value of the property on the date of the loss, or the value of the property on the date of sentencing.

This formula recognizes that a victim’s loss—and corresponding restitution—must include the appreciation of the asset value following the date of the crime. A victim isn’t “made whole” absent compensation for the appreciation of their stolen asset—gains they would plainly have realized absent their being dispossessed of their property because of the crime.

For many objects of fraud, there may be little difference between the value of property on the date of the loss and the value on the date of sentencing. Currency, precious metals, and even securities typically experience only modest fluctuations in value.

Cryptocurrency, on the other hand, is different. Ten Bitcoin stolen a year ago are worth less than half today’s value—a difference of more than half a million dollars. Providing restitution for that appreciation in value—which the victim earned by risking his or her money—is critical to making the victim whole.

Congress certainly thought so when it provided a formula in the MVRA that compensates victims for appreciation or gains between the date of the crime and the date of sentencing.

In most cases, victims have little chance of recovering restitution from the defendant, who is often indigent and may have little prospect for earnings, at least in the short run. But in many crypto cases, the government does seize and forfeit proceeds of the crime—including often substantial amounts of cryptocurrency—which it may then keep under federal forfeiture law.

Forfeiture and restitution have different goals. Forfeiture aims to punish the defendant for gains made from illegal activity while restitution is intended to compensate victims. Forfeited funds therefore belong to the government.

Nonetheless, Congress provided a mechanism called “restoration” through which the DOJ—through its Money Laundering and Asset Recovery Section—may “restore forfeited property to victims”—i.e., use forfeited property to make victims whole where there will be no recovery from the defendants. Using forfeited funds to compensate victims would fulfill Congress’ intent—and basic fairness—to make victims whole with funds traceable to the fraud.

Regulation 28 CFR 9.8(c), however, is regularly applied to severely hamper this goal. It became effective in 1997 after the MVRA was passed and limits the amount that may be restored to a victim from forfeited funds to “the fair market value of the property” as of the loss date.

In other words, a victim won’t be compensated through restoration for any appreciation of their stolen property or gains that occurred following the date of the loss. This restriction applies even if the government seized more than enough property to fully compensate all the victims of the scheme.

The DOJ’s regulation limiting restoration to the value of the property on the date of the loss often leaves the government with a massive windfall at the expense of the victims. It also can’t be squared with Congress’ directive, through the MVRA, that victims be made whole and receive the “full amount” of their losses.

It’s also just plain unfair. Property is forfeited only if it is directly traceable to the offenses of conviction. Forfeited funds, therefore, even if not directly traceable to identified victims, are nonetheless fruits of the crime through which the defendant harmed the victims.

Victims are the ones that sustained the loss, not the government. It’s only right that the victims, rather than the government, receive the benefit of those funds.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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