There have been a number of regulatory updates in the first quarter of the year in the digital asset space. Below we provide an overview of these items.
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SEC Matters
Speeches
Chairman’s Testimony on Virtual Currencies: The Roles of the SEC and CFTC
SEC Chairman Jay Clayton
On February 6, 2018, Chairman Jay Clayton offered testimony to the Senate Committee on Banking, Housing, and Urban Affairs about a wide range of issues concerning virtual currencies. Clayton voiced his support of technological innovations, his concern for Main Street investors, and provided a warning that labeling an asset a “utility token” would not in itself prevent it from being deemed a security.
Releases
Statement on Potentially Unlawful Online Platforms for Trading Digital Assets
On March 7, 2018, the SEC released a public statement affirming its view that platforms trading digital assets that meet the definition of securities and operating as exchanges must register as a national securities exchange or operate under an exemption from registration. The public statement lists considerations for market participants operating online trading platforms, encourages those market participants to consult with legal counsel, and to contact SEC staff for assistance in analyzing and applying the federal securities laws.
Regulators Are Looking at Cryptocurrency
In a joint op-ed published in the Wall Street Journal on January 25, 2018, SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo affirmed their support of innovative financial technologies but warned investors of the risks of new markets. In order to protect investors, the agencies will continue working to bring “transparency and integrity” to the digital asset markets.
SEC Comments on NASAA’s Release Reminding Investors of Risks in Cryptocurrency Investment:
The SEC commended the January 4, 2018 release from the North American Securities Administrators Association stressing concerns relating to cryptocurrencies and ICOs. The SEC’s statement also reminds investors that there is a substantial risk that SEC efforts will not result in recovery of digital asset investments, despite the fact that the SEC and state securities regulators are pursing violations by ICO promoters.
Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings
Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings
Dalia Blass, Director, Division of Investment Management, US Securities and Exchange Commission
In a staff letter to the Investment Company Institute and Asset Management Group, Blass addressed potential issues the SEC has identified concerning registered funds and products focused on cryptocurrency. The letter outlines issues in valuation, liquidity, custody, arbitrage for ETFs, and potential manipulation.
Enforcement
Charges Filed Against Former Bitcoin-Denominated Exchange and Operator
On February 21, 2018, the SEC filed charges against BitFunder and its founder Jon E. Montroll alleging fraud and operating an unregistered securities exchange. According to the complaint, Montroll misappropriated users’ funds and failed to report the theft of more than 6,000 bitcoins as part of a cyberattack.
SEC Suspends Trading in Three Issuers After Questionable Announcements Concerning Digital Assets
On February 15, 2018, the SEC suspended trading in the securities of three companies (Cherubim Interests, Inc., PDX Partners, Inc., Victura Construction Group, Inc.) after the companies made questionable statements about their acquisition of certain cryptocurrency and blockchain technology related assets.
SEC Action against Initial Coin Offering
On January 30, 2018, the SEC obtained a court order for an immediate asset freeze to halt an allegedly fraudulent ICO targeting retail investors and claiming to be the world’s first “decentralized bank.” The complaint alleges that among other violations, the ICO was an illegal offering of securities and that the sponsors made multiple false and misleading statements including that its customers could be covered under federal deposit protections due to its purchase of a bank.
CFTC Matters
Speeches
Testimony of Chairman J. Christopher Giancarlo before the Senate Banking Committee, Washington, D.C.
Christopher Giancarlo
On February 6, 2018, CFTC Chairman J. Christopher Giancarlo offered testimony to the Senate Banking committee concerning virtual currencies. Giancarlo affirmed the commission’s authority to regulate virtual currencies derivatives markets while noting its limited authority to oversee spot virtual currency platforms. Within these parameters, Giancarlo described how the commission has worked toward its goals through enforcement actions, educating investors and market participants, and policy considerations that allow for both innovation and protection.
Keynote Address by Commissioner Brian Quintenz before the DC Blockchain Summit
Brian Quintenz
On March 7, 2018, CFTC Commissioner Brian Quintenz gave the keynote speech at the DC Blockchain Summit, discussing his personal views on digital assets and the role of the CFTC. He discussed the history of the CFTC’s role with respect to digital assets, reminding the audience that “in the derivatives markets, the CFTC has both oversight and enforcement authority, while in the spot markets, or the platforms where commodities themselves are actually bought and sold, the CFTC has only enforcement authority.” He then discussed the future of regulation of digital assets, including possible exploration of “a new, private independent organization [that] could perform an oversight function for U.S. cryptocurrency platforms.”
Releases
CFTC Warns Investors About Virtual Currency Pump-and-Dump Schemes
On February 15, 2018 the CFTC issued its first Customer Protection Advisory focused on virtual currency, specifically warning against “pump-and-dump” schemes. In the advisory, the CFTC asserted its general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity. The CFTC advises all customers to only purchase virtual currency or tokens after thorough research.
CFTC Launches Virtual Currency Resource Web Page
The CFTC launched a virtual currency resource page in its ongoing effort to educate the public about the risks of virtual currencies. The site features an introduction to virtual currencies, consumer advisories, links to relevant CFTC podcasts, and more.
Enforcement
US District Court Issues Preliminary Injunction Order Against Coin Drop Markets
On March 6, 2018, the US District Court of the Eastern District of New York issued a preliminary injunction against Patrick K. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets in connection with the CFTC’s continuing litigation concerning fraud and misappropriation of virtual currencies. Under the terms of the injunction, the defendants are prohibited from engaging in fraudulent activities in violation of the Commodity Exchange Act.
CFTC Charges My Big Coin, Inc. with Fraud and Freezes its Operations
On January 16, 2018, the CFTC filed an enforcement action against Mark Gillespie, and My Big Coin Pay, Inc. in connection with an alleged ongoing virtual currency scam. On the same day, the US District Court for the District of Massachusetts granted an order freezing the assets of the defendants.
CFTC Charges Colorado Cryptocurrency Company with Fraud, Halting Alleged Ponzi Scheme
On January 18, 2018, the CFTC filed a civil enforcement action against Dillon Michael Dean and his company, The Entrepreneurs Headquarters Limited. The complaint alleged ongoing fraud, misappropriation of client funds, and failure to register with the CFTC.
State Matters
Wyoming Governor Signs Five Crypto-related Bills into Law
The governor of Wyoming recently signed into law five bills making the state friendlier to digital asset businesses.
- HB 19 exempts virtual currency from the Wyoming Money Transmitter Act.
- HB 70 provides criteria for which an issuer of virtual currency will not be deemed an issuer of a security in Wyoming.
- SF 111 exempts virtual currency from Wyoming property tax.
- HB 101 allows for electronic corporate records to be stored through blockchain and provides certain requirements of such systems.
- HB 126 authorizes the formation of Series LLCs
Uniform Regulation of Virtual-Currency Businesses Act legislation introduced in several state legislatures
Proposals in Hawaii, Connecticut, and Nebraska have been introduced to adopt the Uniform Regulation of Virtual-Currency Businesses Act (URVCBA) developed by the Uniform Law Commission (ULC), which provides a three-tiered structure for registration and licensing.
Proposed Virtual Currency Regulations Introduced in Hawaii
Multiple bills proposing to regulate cryptocurrency have been introduced in Hawaii. One proposal defines virtual currency and exempts virtual currency money transmitters from the state requirement to possess reserves to cover all outstanding customer investments. A second proposal in Hawaii requires certain persons engaging the exchange, transfer, or storage of virtual currency in the state to be licensed. The proposal also outlines various other requirements for such a licensee, including the requirement to provide extensive personal information.
Proposed Bill in New York would Alter Audit and Licensing Requirements for Crypto-Businesses
A bill has been introduced to the New York Legislature that would change audit and licensing requirements for cryptocurrency related businesses. The bill would prohibit licensing fees targeted at cryptocurrency businesses and establish new audit requirements focusing on security.
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP and focuses his legal practice on the investment management industry. He can be reached directly at 415-868-5345