Below is a summary of some of the significant legal and regulatory actions that occurred over the past weeks. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

U.S. Developments

Regulatory Updates

House Financial Services Committee Holds Hearing on Cryptocurrencies and ICOs

On March 14, 2018, the House Financial Services Committee Subcommittee on Capital Markets, Securities, and Investment held a hearing entitled “Examining Cryptocurrencies and ICO Markets.” The one-panel hearing included the following witnesses: (1) Dr. Chris Brummer (Professor of Law, Georgetown University Law Center), (2) Mr. Mike Lempres (Chief Legal and Risk Officer, Coinbase), (3) Mr. Robert Rosenblum (Partner, Wilson Sonsini Goodrich & Rosati), and (4) Mr. Peter Van Valkenburgh (Director of Research, Coin Center). The subcommittee conducted an overview of the cryptocurrency and Initial Coin Offering (ICO) markets, which have been growing rapidly. The hearing was intended to examine the economic efficiencies and potential capital formation opportunities that cryptocurrencies and ICOs potentially offer to businesses and investors. In the hearing, the subcommittee also reviewed the laws that apply to such sales to ensure that investors receive the “full protections afforded by the federal securities laws.” Financial Services Committee: Capital Markets, Securities, and Investment; Committee on Financial Services Memorandum.

CFTC Takes Public Stance Supporting SROs

U.S. Commodity Futures Trading Commission (“CFTC”) Commissioner Brian Quintenz gave the Keynote Address before the DC Blockchain Summit earlier in March. In this address, Commissioner Quintenz discussed the various stages cryptocurrencies have undergone with regards to the CFTC. In discussing the future of cryptocurrency industry regulation, Commissioner Quintenz emphasized his willingness to explore introducing a private, independent organization to perform an oversight function for U.S. cryptocurrency platforms. Specifically, Commissioner Quintenz opined that the patchwork of state and federal regulators that currently exercise jurisdiction over cryptocurrency companies may not provide the most efficient regulatory or oversight framework. As the different legislative bodies and regulatory agencies sort out the appropriate regulatory framework for cryptocurrencies, Commissioner Quintenz stated that he “believe[s] an SRO [self-regulated organization]-like entity could develop industry standards that could inform, or even serve as a blueprint for, future action.” Commissioner Quintenz went on to discuss other self-regulation that is already occurring in the cryptocurrency sector in the United Kingdom. He further discussed the various advantages that an SRO presents, such as efficiency (e.g., adopting and amending rules more quickly than any federal regulatory regime or being self-funded by members, not federal tax dollars), private membership, self-creation of uniform standards, and inherently incorporating insight from industry participants. Commissioner Quintenz concluded that he believes an “independent body must step up, establish, and enforce the rules of play” and stated that he looked forward to working together with industry participants to “find ways to strengthen the integrity of these growing markets.” Keynote Address by Commissioner Brian Quintenz before the DC Blockchain Summit, March 7, 2018.

And in line with this stance, earlier this week, Commissioner Quintenz issued a public statement outlining general support for “a virtual commodity self-regulatory organization (“SRO”) concept.” Commissioner Quintenz’s comments were in response to an initial outline proposal put forth by Gemini exchange, and he encouraged Gemini and other market participants to promote the qualities of independence, diversity of views and ability to discover wrongdoing within any ultimate SRO construct to ensure that the most integrity is provided to virtual currency markets. CFTC Press Release_03.13.2018.

The public statement follows prior calls from the CFTC for such an SRO, most notably at the CFTC Technology Advisory Committee meeting on February 14, 2018. SROs already exist within markets subject to direct CFTC oversight, such as the National Futures Association (“NFA”) in the derivatives market, and Securities and Exchange Commission oversight, such as the Financial Industry Regulatory Authority in the securities market. At the Technology Advisory Committee meeting, Commissioner Quintenz envisioned a virtual currency SRO that is similar to the NFA, which provides a standards-setting role in the derivatives industry. He noted that any such SRO should “spur the development of standards around cybersecurity policies, data retention, protection of customer accounts, trading practices, and other issues,” as well as potentially assisting exchanges with protecting investors and deterring fraud. February 14, 2018 TAC Meeting Statement.

Establishing an SRO within the virtual currency space would likely be a positive step in ensuring that best practices are adhered to throughout the industry and would allow industry participants to inform and consult upon best practices unique to virtual currencies in an environment with a complex regulatory overlay. In particular, an industry-supported SRO could play a role in informing any future legislation and regulatory engagement, as well as potentially providing a platform for international standards-setting, given the global nature of virtual currencies. There are a number of potential SRO projects, and it remains to be seen how a virtual currency SRO might ultimately be recognized, by both industry and regulators.

SEC Issues Warning About Illegal Exchanges

The SEC issued a public statement on March 7 warning of potentially unlawful online platforms for buying and selling digital assets, including coins and tokens sold in Initial Coin Offerings (ICOs). The statement noted that many of the digital assets sold on online platforms meet the definition of a security under federal securities law. Consequently, such a platform must register with the SEC as a national securities exchange or qualify for an exemption. The SEC warned that unregistered platforms calling themselves “exchanges” are misleading to investors in that they can be mistaken for “national securities exchanges” like the Nasdaq and New York Stock Exchange. The latter are SEC-registered and subject to securities regulation; the former are not. The SEC provided a list of questions for investors to ask about any online platform before deciding to trade and additionally provided resources for investors who are considering trading digital assets. The statement also provided considerations for market participants operating online trading platforms, encouraging such enterprises to contact the SEC for assistance in understanding federal securities law and to consult with legal counsel. SEC Public Statement 3.7.18.

FinCEN is Watching ICOs for BSA Violations

In a recently published letter to the Senate Finance Committee, FinCEN has taken the formal position that when an ICO token is a “convertible virtual currency,” administrators or exchangers of the token would be “money transmitters” under existing FinCEN regulations and interpretations. For more analysis on this issue, see https://www.virtualcurrencyreport.com/2018/03/fincen-is-watching-icos-for-bsa-violations/.

Fintech Updates

U.S. CFTC and UK’s FCA Agree to Collaborate on Fintech Innovation

Chairman J. Christopher Giancarlo of the U.S. CFTC and Andrew Bailey of the United Kingdom’s Financial Conduct Authority (FCA) signed an agreement on February 19, in which both authorities agreed to collaborate and cooperate in their efforts to encourage and foster innovation in Fintech and Regtech. The agreement commits the authorities’ respective Fintech initiatives, LabCFTC in the United States and FCA Innovate in the United Kingdom, to a framework of information sharing and mutual assistance. The agreement, entitled Cooperation and the Exchange of Information on Financial Technology Innovation (“Cooperation Arrangement”) is the first agreement with a foreign regulator for both authorities. Specifically, the Cooperation Arrangement sets forth the following goals and functions between LabCFTC and FCA Innovate:

  • A mechanism to refer “innovator businesses” to each other, for businesses seeking authority to operate in the other country or that have questions about operating in that country.
  • Support for referred “innovator businesses,” which would include providing assistance in understanding the relevant country’s regulatory framework; assistance during the application process, including allocating staff to provide guidance; and assistance with inquiries about ambiguities in existing rules or regulations.
  • Procedures for information-sharing related to Fintech or Regtech, including information about businesses seeking authority to operate in either country; material developments and changes in either authority’s criteria for referring a business for assistance; each authority’s best practices for engaging with Fintech and Regtech innovation; and activities of domestic and international organizations that promote innovation in Fintech and Regtech.
  • Regular meetings with representatives from both authorities to discuss developments, innovations, and other issues of mutual interest in Fintech and Regtech. Additionally, the authorities intend to invite each other to observe proofs of concept, trials, or innovation competitions supported by regulatory sandboxes, accelerators, launchpads, or similar endeavors. CFTC Press Release dated February 20, 2018; Cooperation Arrangement.

European Banking Authority Publishes FinTech Roadmap

The European Banking Authority (“EBA”) published a FinTech Roadmap this week, which sets out its priorities for 2018-2019. As part of this plan, the EBA will establish a FinTech Knowledge Hub to “enhance knowledge sharing and foster technological neutrality in regulatory and supervisory approaches.” The Roadmap identifies the following priorities for this upcoming year: (1) monitoring the regulatory perimeter, including analyzing current authorization and licensing approaches to Fintech and analyzing regulatory sandboxes and innovation hubs; (2) monitoring emerging trends and analyzing the impact on new business models and impacts; (3) promoting the best supervisory practices on assessing cybersecurity and promoting a common cyber threat testing framework; (4) addressing consumer issues arising from Fintech; and (5) identifying and assessing money laundering / terrorist financing risks associated with regulated Fintech firms. EBA Press Release_3.15.18; EBA FinTech Roadmap; EBA FinTech Roadmap FAQs.

Litigation and Court Decisions

New York Court Finds CFTC Has Authority to Sue Under the CEA for Alleged Fraud Involving Digital Currency Earlier this month, a federal judge issued a decision that may make the CFTC the leading regulator addressing fraud in cryptocurrency and virtual currency transactions. In CFTC v. McDonnell, Case No. 18-cv-00361 (E.D.N.Y Mar. 6, 2018) (Weinstein, J.), the court issued a decision and order recognizing the CFTC’s authority to regulate cryptocurrencies, since—according to the judge—they are “commodities” within the definition of the Commodities Exchange Act (“CEA”). The court entered a preliminary injunction order against defendants Patrick K. McDonnell and CabbageTech Corp. d/b/a Coin Drop Markets (“CDM”). The CFTC’s civil complaint against the defendants was filed January 18, 2018 and alleged that the defendants committed acts of fraud and misappropriation in connection with purchases and trading in Bitcoin and Litecoin. The court’s order prohibits the defendants from engaging in fraud in violation of the CEA and requires the defendants to preserve books and records as well as comply with expedited discovery. Among other things, the CFTC ultimately seeks various remedies, including a permanent injunction against future violations of the CEA and federal commodities laws, restitution to allegedly defrauded customers, disgorgement of benefits from violations, civil monetary bans, and trading bans. CFTC Press Release_03.06/2018; Virtual Currency Report: Blockchain Week in Review January 8th – January 19th .

Enforcement Actions

SEC and U.S. Attorney’s Office Bring Actions Against Operator of Defunct Bitcoin Exchange

The U.S. Securities and Exchange Commission (“SEC”) filed a lawsuit on February 21 against Bitcoin exchange BitFunder and its former operator, Jon E. Montroll, alleging that Montroll defrauded users, misappropriated funds, and sold unregistered securities on the platform. On the same day, the U.S. Attorney’s office announced criminal charges against Montroll, claiming that he repeatedly lied in sworn testimony to the SEC to avoid responsibility for a cyberattack on BitFunder’s system.

Montroll operated the BitFunder platform from December 2012 to November 2013. The SEC alleges that the BitFunder platform was run as an unregistered securities exchange through which users could buy and sell virtual shares of various virtual currency-related enterprises in exchange for bitcoins. Customers’ bitcoins were commingled in an online wallet maintained by WeExchange, an Australian virtual currency exchange owned by Montroll, from which he withdrew funds belonging to the platform’s users. During July and August of 2013, a group of BitFunder users hacked into the platform and stole more than 6,000 bitcoins, then valued at approximately $775,075 and worth over $69 million when Montroll was arrested on February 21. BitFunder allegedly lacked the bitcoins to cover user losses; however, Montroll continued to operate the platform until finally closing it in November 2013. In a resulting SEC probe about the cyberattack, Montroll denied that that the hack had been successful and allegedly produced a screenshot that misrepresented the amount of bitcoins available to users on the platform.

The SEC is seeking disgorgement, civil penalties, and a permanent injunction against Montroll and BitFunder. Federal prosecutors are pursuing two counts of perjury and one count of obstruction of justice. SEC Press Release; SEC Complaint; U.S. Attorney Press Release; U.S. Attorney Complaint.

International Developments

Brazil’s Securities and Exchange Commission Shuts Down Mining Investment Scheme

The Brazilian Securities and Exchange Commission (“CVM”) ordered the immediate suspension of mining operations of Hashbrasil on February 28, claiming that the company conducted a public offering without registering with the CVM, in violation of securities law. The CVM claims that Hashbrasil’s operator was soliciting the public to invest in a Bitcoin mining group, an investment opportunity that could be considered a security under Brazilian law. On March 1, the company announced via Facebook that it had temporarily suspended operations. This enforcement action is the latest demonstration of the CVM’s tighter regulation over the cryptocurrency industry in recent months. CVM Announcement.

South Korea Considers Licensing Program for Digital Currencies

A South Korean official announced in February that the government is considering the introduction of a cryptocurrency licensing scheme, similar to New York’s BitLicense. The official, who is participating in a cryptocurrency currency task force, indicated that the Korean government is looking at systems that grant selective permission to exchanges before they are permitted to trade virtual currency. The government is considering legislation modeled after New York’s BitLicense because of the high standards required to qualify for licensure. (Currently, only four exchanges hold a New York State BitLicense.) This announcement signals a shift in policy from the Korean government, which threatened a blanket ban on ICOs and cryptocurrency exchanges in December 2017. The Korean government is not expected to make any new regulation proposals until after nationwide elections in June. BusinessKorea article.

Indonesia Announces Plans to Regulate Fintech Firms

Indonesia’s financial regulator said it was considering setting a cap on interest rates and the size of loans offered by Fintech firms in order to minimize the risk of defaults. Representatives have stated concern that as Fintech loans have grown in popularity, bank lending has slowed to under 10 percent. The director of financial inclusion development at the Financial Services Authority of Indonesia has been quoted as saying. “We don’t want these developing fintechs to become loan shark-like businesses.” Currently, there are 36 registered Fintech firms operating in Indonesia and 42 others in the process to become approved to operate. Reuters.