The New York Attorney General’s office requested information from 13 cryptocurrency exchanges regarding their operations. Only five of the exchanges possess either a BitLicense or a New York limited purpose trust company charter that would appear to enable them to conduct a virtual currency business from NY or to persons in NY. (Click here to access background on NY’s BitLicense requirements in the July 8, 2015 Financial Services Advisory, “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” by Katten Muchin Rosenman LLP.)
Generally, the NY AG office’s questionnaire seeks information on the exchanges’ ownership and control, basic operations and fees, trading policies and procedures, practices regarding outages and other suspension of trading, internal controls, privacy and money laundering, and protections against risks to customer funds. Curiously, the NY AG office also asks for each exchange’s application to the NY Department of Financial Services for a limited purpose charter or BitLicense and all supplemental submissions.
In a letter to all of the exchanges, the NY AG office said that after it reviewed all received material, it would “disclose certain information in a publicly accessible format,” although it did not detail which specific information it was referencing. The NY AG office indicated it would disclose the identity of any platform that did not provide “meaningfully complete responses.”
The five cryptocurrency exchanges that the AG requested information from that either have a limited purpose charter or BitLicense are Coinbase, Inc. (GDAX), Gemini Trust Company, bitFlyer USA, Inc., Circle Financial Limited (Poloniex), and itBit Trust Company. The other exchanges that the AG requested information from are iFinex Inc. (Bitfinex), Bitstamp USA Inc., Payward, Inc., Bittrex, Inc., Binance Limited, Elite Way Developments LLP (Tidex.com), Gate Technology Incorporated (Gate.io), and Huobi Global Limited (Huobi.Pro).
NASAA Warns About ICOs: The North American Securities Administrators Association issued a cautionary guidance regarding initial coin offerings aimed at the retail public. In its guidance, NASAA distinguished between utility tokens, which enable the holder to exchange a coin for a good or service in the future, and equity tokens, which entitle a holder to an interest in the revenue or ownership of the underlying project. NASAA noted, however, that “the regulatory treatment of tokens is evolving,” and that if a utility token is issued for a non-operational project or is intended to be traded on an exchange, it might fall with “the purview of securities regulation.”
FINRA Fines a Tezos Co-Founder: Arthur Meunier a/k/a Arthur Breitman agreed to be suspended for two years from association with any broker-dealer regulated by the Financial Industry Regulatory Authority to settle FINRA charges that, from February 2014 to April 2016, he participated in the development of Tezos, a blockchain technology project, without notifying the broker-dealer he was then employed by of such activity, as required by FINRA rules. (Click here to access FINRA Rule 3270 and here for FINRA Rule 2010.) Mr. Breitman also agreed to pay a fine of US $20,000 to resolve FINRA’s charges. According to FINRA, during the relevant time, Mr. Breitman also falsely attested to his employer broker-dealer that he had disclosed all outside activities to it, when he had not. Founders of Tezos, including Mr. Breitman, have been named in numerous class action lawsuits alleging the unlawful sale of securities and securities fraud, among other offenses. (Click here for an article on one such lawsuit, “Backers of Tezos Initial Coin Offering Named in Prospective Class Action Litigation,” in the November 12, 2017 edition of Bridging the Week.)
Is it a Purchase or a Cash Advance?: Brady Tucker filed a purported class action lawsuit against Chase Bank USA N.A. for, without prior notice, charging higher cash advance fees and interest charges for purchases of virtual currencies with bank-issued credit cards than for other purchases. According to the plaintiff’s lawsuit, filed in a federal court in New York, the bank historically treated purchases of virtual currencies through virtual currency exchanges such as Coinbase as ordinary purchases and charged its standard fees and interest rates. However, alleged Mr. Tucker, without prior notice, the bank began in January 2018 to treat purchases of virtual currencies as cash advances, and charged higher interest rates and fees. Moreover, unlike ordinary credit card interest charges, interest charges on virtual currency purchases began to accrue immediately, said Mr. Tucker. Mr. Tucker claimed that Chase’s alleged unilateral action without prior notice violated applicable law (click here to access 15 U.S.C. §1637(i)(2) and here for Regulation Z enacted thereunder). Mr. Tucker seeks recovery of his purported financial damages, statutory damages and recovery of his costs of pursuing a legal remedy.
SEC Names New Defendant in Centra ICO Lawsuit: The Securities and Exchange Commission amended its April 2 lawsuit against Sohrab Sharma and Robert Farks in connection with the purported illicit initial coin offering by Centra Tech Inc. to add Raymond Trapani, another purported company co-founder. The SEC alleged that Mr. Trapani was the “mastermind” of the allegedly fraudulent ICO. Mr. Trapani was also named in a separate criminal action filed by the United States Attorney's Office in Manhattan, New York. (Click here for background regarding the SEC’s initial lawsuit against Mr. Sharma and Mr. Farks in the article “SEC Seeks to Halt another ICO” in the April 8, 2018 edition of Bridging the Week.)
My View: New York Attorney General’s Office, meet the NY Department of Financial Services. It’s hard to imagine that NY State is so flush with taxpayer funds that it can afford two regulators overseeing the same virtual currency activities. The NY DFS has already taken the lead in this area by adopting rules governing virtual currency businesses. Moreover, NY already requires cryptocurrency exchanges to potentially qualify as both money transmitters and to obtain a BitLicense to do business from or with residents of the state. Dealing with another regulator in the same jurisdiction is an additional, unnecessary burden.
That being said, the questionnaire forwarded to the 13 cryptocurrency exchanges provides an excellent basis for persons to formulate their own due diligence inquiries to potential crypto asset exchanges on which they may conduct business.
Compliance Weeds: As I have previously written, regulated financial services businesses and proprietary trading entities should consider, if they have not done so already, whether they should amend existing employee personal trading polices to expressly address crypto assets. This may be appropriate even if such firms are not engaged in crypto asset activities today.
The easiest approach would be for firms to ban all personal crypto assets trading by employees because of reputational or other perceived risks. However, such a policy may impede hiring or retention of some employees, especially so-called “millennials.”
Alternatively, if firms already have policies addressing employees’ trading of securities, including participation in new offerings of securities, it might be appropriate to consider extending these policies to digital tokens issued as part of initial coin offerings that the Securities and Exchange Commission has said are likely securities. (Click here for background regarding the SEC’s views in the article “SEC Chairman Warns Lawyers Providing ‘It Depends’ Advice on ICOs” in the January 28, 2018 edition of Bridging the Week.)
Moreover, to the extent firms have existing polices addressing employees’ trading of gold or similar commodities, they may wish to extend such policies to employees’ trading of virtual currencies like Bitcoin or Litecoin.
However, because of the SEC’s views, it is not clear today what the bright line is between virtual currencies and security tokens.
Firms that engage in crypto asset activities should consider the potential impact of employees’ front-running firms or a firm’s customers’ trading or engaging in other wrongful conduct. Firms not engaged in crypto asset activities but contemplating engagement should consider the potential implications of employees purchasing crypto assets in advance of any firm announcement with the expectation that the announcement might cause prices of relevant crypto assets to rise.
However, the monitoring of employee crypto asset activity may be difficult, as crypto asset exchanges may not be willing or able to provide statements of employee activity to employers automatically. At best, it may be up to an employee to authorize such third-party transmissions that he or she could activate or deactivate at his or her discretion.