Over the past weeks, there has been a steady drumbeat of public statements from the leadership of the SEC and CFTC about cryptographic and virtual assets.
On January 19, 2018, SEC Co-Enforcement Directors Stephanie Avakian and Steven Peikin and CFTC Enforcement Director James McDonald issued a joint statement regarding virtual currency enforcement. The complete text of the brief statement is as follows:
When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.
Yesterday, shortly after the release of the joint enforcement statement, SEC Chairman Jay Clayton delivered public remarks concerning virtual assets at the Securities Regulation Institute in San Diego, a prominent industry conference. Chairman Clayton began with a warning to market professionals and particularly attorney gatekeepers in the context of virtual asset offerings: “My first message is simple and a bit stern. Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering (“ICO”) space, they can do better.” Chairman Clayton’s comments highlight the importance of obtaining legal advice in connection with potential transactions involving cryptographic or virtual assets; Chairman Clayton also expressly stated that he has instructed the SEC staff to be on “high alert” for “approaches to ICOs that may be contrary to the spirit of our securities laws.” The full text of Chairman Clayton’s statement is available here.
Other significant public pronouncements from Chairman Clayton and CFTC Chairman J. Christopher Giancarlo, as well as a joint statement from Chairman Clayton and SEC Commissioners Kara M. Stein and Michael S. Piwowar, preceded the joint enforcement statement and Chairman Clayton’s statement yesterday.
On January 4, 2018, CFTC Chairman Giancarlo issued a statement, noting the “significant opportunities and challenges” of virtual currency and virtual currency derivatives. Chairman Giancarlo’s statement follows SEC Chairman Clayton’s stern and detailed discussion of cryptocurrencies, digital tokens, and ICOs released contemporaneously with the SEC’s December 11, 2017 cease-and-desist proceedings against Munchee, Inc. (an issuer of digital tokens in an ICO). The full text of Chairman Giancarlo’s statement is available here, Chairman Clayton’s statement is available here, and our analysis of the cease-and-desist proceedings brought against Munchee is available here.
CFTC Chairman Giancarlo’s statement makes clear the CFTC’s focus on the risks associated with virtual currencies:
The CFTC is cognizant of the considerable risks of virtual currencies like Bitcoin. In addition to the nascent stage of the technology itself, risks associated with virtual currencies include: operational risk of unregulated and unsupervised trading platforms; cybersecurity risks of hackable trading platforms and virtual currency wallets; speculative risks of extremely volatile price moves; and fraud and manipulation risks through traditional market abuses of pump and dump schemes, insider trading, false disclosure, Ponzi schemes and other forms of investor fraud and market manipulation.
The statement reaffirms the CFTC’s commitment to asserting regulatory authority with respect to virtual currencies and derivatives of virtual currencies. Indeed, Chairman Giancarlo notes that “ignoring virtual currency trading will not make it go away . . . . The CFTC has an important role to play.”
Also on January 4, 2018, SEC Chairman Clayton and Commissioners Kara M. Stein and Michael S. Piwowar issued a joint statement to “commend” the North American Securities Administrators Association (“NASAA”) on its recent release highlighting “important issues” relating to cryptocurrencies, ICOs, and other cryptocurrency-related investment products. Their joint statement praises NASAA’s statement that cryptocurrencies “lack many important characteristics of traditional currencies” and are instead being promoted more as “investment opportunities” than “efficient mediums for exchange.” The full text of the joint statement is available here and the NASAA Release is available here.
The joint statement follows SEC Chairman Clayton’s detailed, seven-page December 11, 2017 statement, expressly directed at both “main street” retail investors and seasoned market professionals. The length, breadth, and tone of the Chairman’s statement is significant, explicitly detailing the Chairman’s “general views” on the cryptocurrency and virtual asset markets and reflecting substantial concern with the state of cryptocurrency and virtual token offerings and markets. The statement, which contains numerous bolded passages, urges caution and thoughtfulness in the evaluation of, among other things, (i) the unique risks attendant to today’s crypto assets and markets and (ii) the application of the existing securities regulatory framework to the new assets.
Emphasis on Risks to Retail Participants; Plea for Caution
The first half of the statement addresses considerations for main street investors, and opens with a boldface cautionary warning:
A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.
The statement urges due diligence on the part of retail investors, and highlights that no cryptocurrency offerings or ICOs have been registered with the SEC or been approved for listing on a national exchange (including as part of exchange-traded holding structures, such as ETFs. Similarly, the statement highlights the international nature of existing crypto asset markets and infrastructure, noting in another boldface passage that “funds may quickly travel overseas” and that, as a result, “risks can be amplified, including the risk that market regulators, such as the SEC, may not be able to effectively pursue bad actors or recover funds.”
Warning for Gatekeepers and Professionals
The second part of Chairman Clayton’s statement relates to the role of market professionals in policing crypto asset transactions and their approach to evaluating crypto assets within the existing securities regulatory framework. Chairman Clayton offered comments about many existing assertions by issuers and other professionals (including references to the utility of the relevant asset) that appear to “elevate form over substance”. He cautioned that “[m]erely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” This is an important reminder for market participants to focus on the particular facts and circumstances pertaining to each crypto asset.
He also warned purveyors of cryptocurrencies, stating that “before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, its promoters must either (i) be able to demonstrate that the currency or product is not a security or (ii) comply with applicable registration and other requirements under our securities laws.” “By and large,” he writes,
the structure of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws . . . . I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement against those that conduct initial coin offerings in violation of the federal securities laws. (Emphasis added.)
The flurry of public statements, taken together with the SEC Staff’s recent detailed report of investigation (discussed in another of our client alerts, available here) and the Munchee cease-and-desist order, can reasonably be viewed as a proverbial shot-across-the-bow of any crypto issuers and market professionals not mindful of U.S. regulatory considerations. The number and frequency of statements by CFTC and SEC leadership are a warning that crypto-related enforcement actions are likely to increase in scope and magnitude.
Recent events also demonstrate that risks are not limited to U.S. federal regulation of securities and commodities. For example, the SEC worked with Canadian securities regulators to halt an alleged ICO scam, as explained in our recent client alert, available here. And, last week, the Office of the Massachusetts Secretary of the Commonwealth filed an administrative complaint against ICO issuer Caviar and its founder Kirill Bensonoff, alleging violations of Massachusetts securities law and regulations. That administrative complaint is available here.