Crypto Trader Tests If Privacy Right Protects Exchange Records

Those who regularly exchange or sell cryptocurrency should pay careful attention to the implications of Harper v. Werfel, a case before the US Court of Appeals for the First Circuit that could decide whether there’s a constitutional right of privacy in cryptocurrency exchange records.

Harper challenges the IRS’s use of a John Doe summons to obtain individuals’ financial information from a crypto exchange. A John Doe summons under 26 U.S.C. Section 7602(a) allows the IRS to serve an information request on any person or entity without first receiving judicial approval so long as that information may reveal an individual’s tax liability. Harper raises the question whether judicial approval is necessary before issuing such a summons.

In the last few years, the IRS has issued John Doe summonses to third-party virtual currency exchanges—i.e., crypto lenders and exchanges—as part of a heightened effort to crack down on tax fraud.

The idea is that the information obtained from a John Doe summons helps the IRS see whether individuals are properly reporting their income—gains or losses in crypto.

Enter James Harper. In 2016, the IRS served a John Doe summons on a popular crypto exchange seeking two years’ worth of detailed financial records for thousands of account holders, including Harper.

Harper later received a letter from the IRS notifying him that the IRS had used a John Doe summons to obtain information detailing his virtual currency activity.

Harper sued, arguing that the IRS, in issuing a John Doe summons to obtain his financial records from a third-party exchange, violated his Fourth Amendment right—among others —under the US Constitution.

Initially, the IRS moved to dismiss, contending that Harper’s claims were barred by the Anti-Injunction Act. This act states that no lawsuit “for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.”

The district court agreed with the IRS, but the First Circuit reversed, holding that the act didn’t bar Harper’s lawsuit: Whereas the act bars suits directed toward restraining “the assessment or collection of any tax,” Harper’s suit was directed toward restraining an antecedent information-gathering technique. That distinct challenge, the First Circuit concluded, may proceed to a merits determination.

On remand, the parties teed up the Fourth Amendment issue, and the district court ruled in favor of the IRS through an application of the “third-party doctrine,” which states that Harper had no expectation of privacy and thus no Fourth Amendment right to his financial records because he entrusted them with a third party.

In other words, Harper voluntarily gave up any right to privacy in his property by voluntarily disclosing his activity to an outsider.

Harper appealed again to the First Circuit. On appeal, Harper argues that the third-party doctrine doesn’t apply because it doesn’t matter where he stores his financial records, which are his property.

His entering a contractual agreement with the crypto exchange when he signed up for its services is akin to entering a contract for safekeeping confidential property, which retains a meaningful element of privacy.

Moreover, the exchange agreed to keep his personal information confidential, which is unlike the situation in other third-party doctrine cases.

Further, Harper argues that the account information kept by virtual exchanges provides an “intimate window into a person’s life and is protected under the Fourth Amendment.”

This argument tracks recent US Supreme Court precedent addressing the constitutional intersection between law enforcement techniques and the increasingly sophisticated methods of data collection by third parties.

Just like a cellphone is no ordinary object that may be searched incident to arrest without a warrant, and just like cell-site location information is unlike the numbers dialed on a telephone that receive no Fourth Amendment protection—the argument goes—detailed personal and financial information provided to crypto exchanges is unlike more limited forms of information disclosed to third parties.

Whether Harper’s arguments will succeed remains to be seen. To prevail, Harper will likely have to persuade the First Circuit that crypto records are qualitatively different from run-of-the-mill bank records—that crypto records are, in essence, a manifestation of increasingly sophisticated technology that reveals a mosaic of a person’s life—such that one’s expectation of privacy can be said to have been violated.

That showing, in turn, will rest on how well Harper developed those facts before the district court. On that front, there are potentially robust factual dissimilarities between standard bank records and crypto records. For example, some crypto exchanges have particularly stringent know your customer requirements as well as broad e-data collection practices that gather wide swaths of personal information.

The scope of the summons at issue may only magnify the Fourth Amendment issue: Summonses that seek more forms of information over a longer time may be at more risk than more narrowly tailored summonses.

As crypto becomes more prevalent, the Fourth Amendment issue is arguably put into sharper relief. If we haven’t yet crossed the Rubicon, the day may soon arrive where the analogy between bank records and crypto records will have reached the breaking point. Contending otherwise may indeed be “like saying a ride on horseback is materially indistinguishable from a flight to the moon,” as Chief Justice John Roberts wrote in the opinion.

In all events, crypto traders should be aware that the IRS continues to issue John Doe summonses to exchanges. The First Circuit may soon tell us whether those efforts violate traders’ constitutional rights.

The case is Harper v. Werfel, 1st Cir., No. 23-1565, IRS brief filed 12/21/23.

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

Author Information

Daniel H. Ahn is partner at Reed Smith with focus on investigations, and former supervisory federal prosecutor.

Mark E. Bini, partner at Reed Smith, is a former federal and state prosecutor who represents corporations and individuals in connection with government and internal investigations.

Rizwan A. Qureshi, partner at Reed Smith, is a former federal prosecutor who represents public and privately-held companies.

Reed Smith’s Philip Chang contributed to this article.

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