The second quarter offers notable regulatory updates in the digital asset space. For your convenience, we provide an overview of these items down below.
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SEC MATTERS
Speeches & Testimony
Chairman Testifies on Cryptocurrencies Before the House Committee on Appropriations
On April 26, 2018, Securities and Exchange Commission (“SEC”) Chairman Jay Clayton testified before the Financial Services and General Government Subcommittee of the House Appropriations Committee that digital assets are divided into 2 categories: (1) a “pure medium of exchange”—considered to be “not a security”; (2) tokens—a tool “to finance projects.” Given the uncertainty around cryptocurrencies, this may suggest that even the SEC might not readily view all tokens as securities yet.
SEC Director Hinman Testifies Before the House That Many ICOs are Securities Offerings, Certain Utility Tokens Do Not Have Hallmarks of a Security
On April 26, 2018, SEC Director William Hinman stated his position that it is “hard to have an initial sale without a securities offering.” Consequently, Hinman believes that initial coin offerings (“ICOs”) will likely require registering as a securities offering or operating under an exemption. He clarified that it is possible for a token not to have the hallmarks of a security if the token was purchased solely for its functional use and not as an investment. For many issuers, it could mean that they can offer tokens for sale by relying on appropriate exemptions without having to comply with the SEC securities registration.
SEC Director Hinman Speaks at the Yahoo Finance All Markets Summit on Crypto
On June 14, 2018, SEC Director of the Division of Corporation Finance William Hinman spoke at the Yahoo Finance All Markets Summit on Crypto in San Francisco. He addressed questions regarding ICOs and token sales and whether a digital asset can be something other than a security. He mentioned that currently, neither Bitcoin nor Ether meet the Howey test. However, he cautioned that classification of whether an instrument is a security is not static and the classification can change as the instrument changes.
Releases
SEC Creates Senior Advisor for Digital Assets and Innovation Position
On June 4, 2018, the SEC announced that Valerie A. Szczepanik would be the agency’s first ever Senior Advisor for Digital Assets and Innovation. This newly created position will allow the SEC to explore how U.S. securities laws would apply to digital asset technologies such as ICOs and cryptocurrencies. Ms. Szczepanik has been with the SEC since 1997. During her tenure, she has been an Assistant Director for the Division of Enforcement’s Cyber Unit. Currently, Szczepanik serves as the Head of the SEC’s Distributed Ledger Technology Working Group, Co-Head of the Dark Web Working Group, and a member of the FinTech Working Group.
Enforcement
SEC Takes Civil Actions Against Fraudulent ICO
On April 2, 2018, the SEC filed a complaint in the United States District Court for the Southern District of New York against Centra Tech., Inc. (“Centra”) for raising at least $32 million in unregistered securities through a fraudulent ICO. Centra falsely claimed that it had partnered with VISA, Mastercard, and Bancorp to create a “crypto debit card.” The complaint seeks a permanent injunction to stop Centra’s activities and to return the ill-gotten gains to investors. The U.S. Attorney’s Office has also filed criminal charges against the two founders.
SEC Files Charges Against Titanium Blockchain
On May 22, 2018, the SEC filed charges in the United States District Court for the Central District of California against Titanium Blockchain for violating antifraud and registration provisions under federal securities laws. The company used false corporate relationships and testimonies to inflate the values of their digital assets. Under the guise of an ICO, they fraudulently raised up to $21 million in cash and digital assets.
Other
SEC Creates Mock Initial Coin Offering
The SEC has created howeycoins.com. The website is designed to educate the public about fraudulent ICOs and how to avoid being a victim.
CFTC MATTERS
Advisory
The CFTC Issues Advisory on Virtual Currency Derivatives
On May 21, 2018, the Commodity Futures Trading Commission (“CFTC”) issued key expectations for exchanges and clearinghouses regarding virtual currency derivative products. These include: i) enhanced market surveillance; ii) close coordination with the CFTC surveillance group; iii) large trader reporting; iv) outreach to members and market participants; and v) derivative clearing organization’s risk management. For more details on these key points, please refer to our second quarterly update.
Speeches
CFTC Gives Keynote at the FIA 40th Annual Law & Compliance Division Conference on the Regulation of Futures, Derivative, and OTC Products, Washington, D.C.
CFTC Commissioner Rostin Behnam. On May 3, 2018, CFTC Commissioner Rostin Behnam spoke at the Futures Industry Association’s 40th Annual Law & Compliance Division Conference on the Regulation of Futures, Derivative, and OTC Products. In his speech, the Commissioner noted that institutions look at digital assets as something more than a currency. He also acknowledged the National Futures Association’s work on understanding and regulating virtual currencies and their derivatives.
Commissioner Quintenz Announces the Establishment of TAC Subcommittees
CFTC Commissioner Brian Quintenz. On June 4, 2018, CFTC Commissioner Brian Quintenz announced the creation of the Technology Advisory Committee’s (“TAC”) four new subcommittees. The subcommittees will be tasked with exploring automated and modern trading markets, cybersecurity, distributed ledger technology and market infrastructure, and virtual currencies.
Enforcement
CFTC Files Complaint Regarding Fraudulent ATM Coin
On April 16, 2018, the CFTC filed a complaint against three investment funds for their connection with a “binary options” scheme that defrauded at least 6 U.S. clients of about $618,810. The managers invited investors to transfer their fund balances to a virtual currency firm in return for the fraudulent virtual currency called “ATM Coin.” Neither the defendants nor the executed transactions were registered with the CFTC or a registered exchange. One of the fund managers also faces criminal charges for altering records and obstructing the FBI investigation.
NFA MATTERS
Notice to Members
NFA Encourages FCMs and IBs to Review OFAC FAQs for Compliance Obligations
On May 3, 2018, the National Futures Association (“NFA”) released a notice recommending that futures commission merchants (“FCMs”) and introducing brokers (“IBs”) review the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) FAQs about compliance and sanctions with regard to illicit digital currency activities. The FAQs detail OFAC’s goal to combat terrorism and criminal exploitation of digital transactions, as well as compliance obligations in dealing with blocked persons or property.
FINRA MATTERS
Enforcement
FINRA Suspends a Member for Failure to Disclose Outside Business Activity.
On April 18, 2018, FINRA issued a $20,000 fine and a two-year suspension to a broker for failure to disclose his private blockchain business activity with his firm. According to FINRA, all firms’ employees must report outside business activities and any material changes to their firms. This rule is intended to strengthen investor protections against outside activities.
STATE MATTERS
California Legislation
The following bills regarding the digital asset space are moving through the California legislature.
- CA AB-2658: it would define blockchain technology in California and create a government working group to evaluate the use of blockchain technology by CA businesses and the state government. The bill passed the State Assembly on May 30, 2018 and is currently in the State Senate.
- CA SB-838: it would allow certain privately-owned corporations to amend their articles of incorporation to include provisions for the use of blockchain technology in recording information related to stock transactions. The bill passed the State Senate on May 17, 2018 and is currently in the State Assembly.
Colorado Division of Securities Participates in Coordinated International Crypto Crackdown
On May 3, 2018, the Colorado Securities Commission announced that it signed orders requiring Linda Healthcare Corporation and Broad Investments, LLC to cease and desist from selling securities in the state. The companies violated Colorado securities laws by promoting ICOs to Colorado residents without disclosing the risks involved.
Florida Chief Financial Officer Announces New Cryptocurrency Oversight Position
Jimmy Patronis, Florida Chief Financial Officer, released a statement on June 26, 2018 that Florida would be creating an oversight position for its cryptocurrency industry. In coordination with the Office of Financial Regulation and the Office of Insurance Regulation, this new oversight position aims to develop policy, legislation, and regulation regarding cryptocurrency.
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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