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

SEC Chairman Testifies Before the House Committee on Appropriations

U.S. Securities and Exchange Commission (SEC) Chairman Jay Clayton testified on the issue of cryptocurrencies on April 26 in a hearing before the Financial Services and General Government Subcommittee of the House Committee on Appropriations. In his testimony, Chairman Clayton clarified his position on how the SEC approaches regulatory oversight of cryptocurrencies. Clayton divided cryptoassets into two categories: (i) a “pure medium of exchange,” e.g. Bitcoin, which he indicated is considered to not be a security; and (ii) tokens, which are used to finance projects. Referencing a statement he made earlier this year about ICOs, Clayton stated that there are very few tokens, and none that he has seen, that aren’t securities. He said that the SEC should continue to regulate tokens deemed to be securities, as securities, based on the information provided in disclosures from financial firms and individuals. SEC Clayton Testimony 4.26.18; Hearing Webcast

SEC Director Testifies Before the House Committee on Financial Services

On the same day as SEC Chairman Clayton testified before the House Committee on Appropriations, SEC Director of the Division of Corporation Finance, William Hinman, testified before the House Committee on Financial Services Subcommittee on Capital Markets, Securities, and Investment, discussing the role of his Division in the areas of cybersecurity, cryptocurrencies, and initial coin offerings (ICOs). Congressman Emmer (R-MN) specifically addressed ICOs, asking whether a utility token sale could ever be considered not to be a security, noting that the purpose of issuing such tokens is not capital formation. Director Hinman stated his position that it is “hard to have an initial sale without a securities offering.” Consequently, initial sales will likely require registering as a security or operating under an exemption. He clarified that it is possible for a token to not have the hallmarks of a security, in which case the holder has purchased the token solely for its functional use, not as an investment. He noted that in certain instances, the fundraising is intended to eventually build a platform where a token is exchanged for a good or service on a decentralized network. In such decentralized networks, he noted, there wouldn’t be an asymmetry of information between a central actor and investors. (Instead, the issuer of the token and the token holder share the same information.) Questioned how to improve regulatory clarity so that entrepreneurs would not come under unwarranted SEC scrutiny (e.g. when issuing utility tokens), Director Hinman stated that the SEC is meeting with issuers of non-security/utility tokens to discuss how such token sales might be structured to avoid SEC action.

Director Hinman’s opening remarks addressed the Division of Corporation Finance’s roles and priorities with respect to cybersecurity, cryptocurrency and ICOs more broadly. The Division of Corporation Finance is authorized under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), and is tasked with reviewing the disclosures and financial statements of reporting companies to ensure compliance with disclosure and accounting requirements, and conduct selective review of filings that it deems warrant additional scrutiny. Among the Division’s current priorities are:

  1. Cybersecurity: Director Hinman referenced the SEC’s press release in February 2018, which issued guidance to assist companies in preparing disclosures about cybersecurity risks and incidents, reminding companies of the importance of the disclosure controls and their role in ensuring that a company’s policies and procedures guard against insider trading during the period between the discovery of a cybersecurity breach and public disclosure.
  2. Cryptocurrencies and ICOs: Director Hinman noted that his Division is dedicating significant attention and resources to these areas, stating that ICOs have the potential to facilitate capital formation, but must comply with federal securities law to prevent fraud and abusive market practices. He stated that the Division’s primary goal regarding ICOs is to ensure investors are protected and are receiving adequate information to make investment decisions.

FinCEN Issues Advisory on FATF’s List of Jurisdictions with AML/CFT Deficiencies

On April 27, the Financial Crimes Enforcement Network (FinCEN) issued an advisory directed at U.S. financial institutions to take note of the Financial Action Task Force’s (FATF’s) updated list of countries with regulatory deficiencies in international anti-money laundering and combatting the financing of terrorism (AML/CFT) standards. The FATF released the updated list of jurisdictions on February 23, 2018 in a public statement and publication on its website. FinCEN recommends U.S. financial institutions review the updated list and comply with the existing UN Security Council Resolutions on each jurisdiction where deficiencies in AML/CFT were found. Countries remaining on the list and which were of particular focus in the FinCEN advisory include Iran and North Korea. Serbia has been added to the list; Bosnia-Herzegovina has been removed. To safeguard against money laundering and terrorist financing, the FATF urges to financial institutions to apply countermeasures (e.g. against North Korea) and/or implement enhanced due diligence policies (e.g. against Iran). The remaining countries identified on the list are Ethiopia, Iraq, Serbia, Sri Lanka, Syria, Trinidad and Tobago, Tunisia, Vanuatu, and Yemen. With respect to these countries, the FATF reminds U.S. financial institutions to comply with general due diligence obligations for foreign financial institutions under 31 CFR § 1010.610(a) and 31 U.S.C. § 5318(h). FinCEN Advisory 4.27.18; FATF Public Statement 2.23.18; FATF Publication 2.23.18

International Developments

France Reclassifies Cryptocurrency

The French Council of State announced that it has changed the tax rate of cryptocurrency sales from 45 to 19 percent because of a reclassification of cryptocurrencies, which will now be considered movable property. The exception to this classification are coins earned directly from mining operations, which will be taxed as income. Le Monde article 4.26.18

Japanese Regulators Pressure Exchanges to Drop Cryptocurrencies

Japan’s Financial Services Agency (FSA) is discouraging cryptocurrency exchanges to stop handling certain cryptocurrencies, including Monero, Zcash and Dash, that it believes are widely used by, and gaining popularity with, criminal actors. According to the FSA, it has identified certain cryptocurrencies as vulnerable to use by bad actors because of the difficulty of tracing them and identifying the recipients. After the hack of Coincheck in February 2018, the FSA shutdown two cryptocurrency exchanges and has boosted its regulatory actions and inspection procedures. Forbes article 4.30.18

Iran Bans Cryptocurrencies but Continues Developing its Own Local Currency

On April 22, Iran’s Central Bank banned trading of digital currencies identified by Iran’s anti-money laundering body in December 2017, including Bitcoin, citing money laundering concerns. The Bank issued a statement in which it directed banks and currency exchanges to refrain from engaging in any sale or purchase of the identified cryptocurrencies. Reuters article 4.22.18

On April 28, a government minister of Iran stated that the country has developed an experimental local cryptocurrency, which would not be affected by the country’s wider ban on cryptocurrencies. Iran’s Central Bank clarified that the existing ban on cryptocurrencies does not apply to domestically-developed cryptocurrencies. Reuters article 4.28.18

Kenya Hints at Establishing Blockchain Task Force

On April 25, the Kenyan Capital Markets Authority (CMA) released a Capital Market Soundness Report, which proposed creating a task force to address challenges related to digital currencies and ICOs. The special unit would be a special unit under the purview of all relevant regulators including the CMA and the Central Bank of Kenya (CBK). This marks a shift in the CMA’s and CBK’s previous position in ICOs. In February 2018, the CMA warned investors against ICOs and stated that all offerings were unapproved, unregulated and highly speculative investments. The CBK Deputy Governor spoke at the Euromoney East Africa Conference in early April and stated that the country’s approach to blockchain technologies should be to cautiously embrace while addressing potential risks. CMA Report Vol. VI, Quarter 1 2018