A second federal court has ruled that the Commodity Futures Trading Commission has jurisdiction to bring enforcement actions against persons engaged in purported fraudulent activities involving cryptocurrencies.
In an action against My Big Coin Pay, Inc., Randall Crater and certain relief defendants, the US District Court in Massachusetts held that cryptocurrencies are commodities as defined under applicable law, and that the CFTC’s authority to bring enforcement actions under its fraud-based manipulation authority extends to fraud cases that are not grounded in illicit market conduct. (Click here for background regarding the CFTC’s enforcement action in the article “CFTC Sues Unregistered Company and Promoters of Fake Virtual Coin for Alleged Fraud and Operating Purported Ponzi Scheme” in the January 28, 2018 edition of Bridging the Week.)
In August 2018, a federal court in Brooklyn, New York, reached the same conclusion in a CFTC enforcement action against Patrick McDonnell and Cabbagetech Corp. (Click here for background in the article “Federal Court Enters Final Judgment Against Alleged Virtual Currency Fraudster; Confirms CFTC Authority to Bring Enforcement Action” in the August 26, 2018 edition of Bridging the Week.)
The Massachusetts court claimed that the digital coin at issue in this action – My Big Coin – was a cryptocurrency and satisfied the definition of commodity under the Commodity Exchange Act. (Click here for the definition of commodity under the Commodity Exchange Act, 7 U.S. Code § 1a(9).)
Mr. Crater and the relief defendants had argued in papers to support a motion to dismiss that the CFTC has no jurisdiction to bring its enforcement action alleging fraud in connection with the sale of the virtual currency known as “My Big Coin,” because the virtual currency was not a commodity under applicable law. This is because, said the defendants, the virtual currency was neither a good nor an article, or a service, right or interest in which contracts for future delivery are dealt in. If My Big Coin is not a commodity, the CFTC has no authority to prosecute a fraud case against them under applicable law, claimed the defendants.
The court rejected defendants’ view, noting that “commodity” under applicable law is defined “generally and categorically, not by type, grade, quality, brand producer, manufacturer, or form.” As a result, if there is futures trading within a certain class, all items within the class are commodities, said the court. Since there a multiple futures contracts that reference bitcoin and bitcoin is a cryptocurrency, all cryptocurrencies are commodities, ruled the court.
Additionally, the court held that the CFTC’s authority to prosecute fraud-based manipulation extends to fraud “even in the absence of market manipulation.” Although the court acknowledged that there were “some isolated statements in the legislative history” of the relevant Dodd-Frank provision supporting a contrary view, the court said this was “insufficient to overcome the broad language in the statute as it was passed.”
In other matters involving crypto assets:
CFTC and SEC Charge Non-US Company With Illegally Engaging in Off-Exchange Margined Transactions With Retail Customers While Accepting Bitcoin as Payment: Both the CFTC and the Securities and Exchange Commission brought enforcement actions against 1pool Ltd. – an online trading platform – and it chief executive officer and principal, Patrick Brunner, for engaging in illegal transactions settling in bitcoin with retail clients and not being properly registered. The CFTC claimed that contracts for difference traded on ipool that referenced gold and West Texas Intermediate crude oil, among other commodities, were illegal off-exchange margined transactions. Moreover, ipool failed to register as a futures commission merchant, as required by law and to have a necessary supervisory system, charged the CFTC. The SEC claimed that ipool-offered CFDs that tracked the price of stocks were security-based swaps, and its offer and sale of such products to US retail persons violated various securities laws, including requirements that security-based swaps be registered with it, and that dealers in CFDs in security products be registered as dealers. These lawsuits were filed by the CFTC and SEC in a federal court in the District of Columbia.
CFTC Charges Individual With Impersonating CFTC Staff to Steal Bitcoin: The CFTC filed an action against two persons – one using the name Morgan Hunt doing business as Diamonds Trading Investment House and the other employing the name Kim Hecroft doing business as First Options Trading – for engaging in an illegal scheme to obtain bitcoin from retail investors purportedly to trade leveraged or margined foreign currency contracts, binary options and diamonds. In connection with the alleged fraud, the CFTC charged that the defendants impersonated a CFTC investigator and forged documents to suggest they were drafted by the Office of General Counsel.
My View1: The definition of a commodity under applicable law is clear:
The term “commodity” means wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice, and all other goods and articles, except onions …and motion picture box office receipts (or any index, measure, value, or data related to such receipts),and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in. [Emphasis added.]
Thus, a commodity includes 30 specifically enumerated commodities and all services, rights and interests in which contracts are presently or in the future dealt in.
However, the definition of a commodity also includes “all other goods and articles” except for onions and motion picture box office receipts. This clause stands alone in the CEA definition of commodity and is not modified by the qualification, “in which contracts for future delivery are presently or in the future dealt in.”
As a plain review of the placement of commas and the two uses of the word “and” make clear in the CEA definition of commodity, only the phrase “and all services rights and interests” is modified by the phrase "in which contracts for future delivery are presently or in the future dealt in.”
Notwithstanding, the court in My Big Coin Pay read this definition differently. The court said that the qualifier “dealt in” applies to both goods and articles as well as services, rights and interests. Although the court held for the CFTC in considering defendants’ motion to dismiss this enforcement action, such a view could severely limit the CFTC’s ability to bring enforcement actions involving new classes of commodities going forward until such time as it first approves a futures contract on a product within such class. This appears to be an unnatural reading of the relevant provision of law.
The definition of commodity is very broad. It includes (1) 30 enumerated commodities plus all (2) other goods and articles, as well as (3) “all services, rights and interests... in which contracts for future delivery are presently, or in the future dealt in.” Sentence construction is meaningful.
My View2: During the last few weeks, federal courts have issued a triumvirate of decisions that some may regard as the three horsemen of the cryptolypse in that they generally confirm CFTC and the Securities and Exchange Commission views regarding the reach of their enforcement authority.
In the first action during August 2018, a federal court in Brooklyn, New York, sided with the CFTC and entered an order of permanent injunction, imposed a civil penalty of approximately US $871,000, and ordered restitution of approximately US $290,000 against Cabbagetech Corp. and Patrick McDonnell, its owner and controller for unlawfully soliciting customers to send money and virtual currencies for virtual currency trading advice and for the discretionary trading of virtual currencies. In ruling against the defendants, the federal court held that virtual currencies are commodities and that the CFTC had jurisdiction to bring its enforcement action relying on the fraud-based manipulation prohibition in Dodd-Frank.
In the first half of September 2018, a different judge in the same US federal court in Brooklyn, New York, declined to dismiss a criminal indictment against Maksim Zaslavskiy charging him with securities fraud and related offenses in connection with two cryptocurrency investment schemes and their related initial coin offerings.Mr. Zaslavskiy had argued that the indictment should be dismissed because his activities did not involve securities and that the relevant law prohibiting fraud in connection with the offer and sale of securities was unconstitutionally vague.
The court rejected Mr. Zaslavskiy’s arguments, saying that, at least for the basis of the defendant’s motion to dismiss, the government had sufficiently alleged that the relevant digital assets were securities and that the relevant law prohibiting fraud is not unconstitutionally vague as applied in his case. In taking this view, the court adopted the arguments of the US Department of Justice and the SEC. (Click here for background on this decision in the article “Brooklyn Federal Court Rules ICO-Issued Digital Assets Could Be Securities” in the September 16, 2018 edition of Bridging the Week.)
The latest decision by the federal court in Massachusetts generally follows the reasoning of the Cabbagetech decision, and is another victory for the CFTC – although a different outcome is possible after a jury considers all the relevant facts.
The age of cryptocurrencies began less than 10 years ago when Satoshi Nakamoto mined the first 50 bitcoins. For the first time, courts are now providing their views on how crypto assets may be regulated. Although these views are mostly consistent with the CFTC's and SEC's perspectives, it is better to have certainty rather than uncertainty.