This week, there have been three major developments involving the regulation of cryptocurrencies in the United States:
- a federal court in Brooklyn, NY affirmed that the Commodity Futures Trading Commission has the authority to bring an enforcement action against a person that has engaged, is engaging or may engage in fraud involving a virtual currency, even if the transaction does not involve a futures contract or other derivatives contract based on a virtual currency;
- the Financial Crimes Enforcement Network of the US Treasury Department released a letter draft to Sen. Ron Wyden in February, stating that developers or exchanges that exchange initial coin offering issued coins or tokens for fiat or virtual currency must be licensed as money service businesses unless otherwise registered with the CFTC or the Securities and Exchange Commission, and comply with all applicable MSB anti-money laundering obligations; and
- the SEC again stated that all cryptocurrencies constituting securities may only be traded on or subject to the rules of a national securities exchange unless exempt from such requirements.
On March 6, a federal court in Brooklyn, NY upheld the authority of the CFTC to exercise its enforcement power over fraud to virtual currencies sold in interstate commerce and granted the CFTC an injunction against Patrick McDonnell and Cabbagetech, Corp. Earlier this year, the CFTC charged the defendants with unlawfully soliciting customers to send money and virtual currencies for virtual currency trading advice and for the discretionary trading of virtual currencies by Mr. McDonnell. (Click here for details of the CFTC’s lawsuit in the article “CFTC Files Two Enforcement Actions Charging Fraud in Connection with Cryptocurrencies Sale Schemes” in the January 21, 2018 edition of Bridging the Week.)
In ruling for the CFTC, the court held that virtual currencies are commodities under applicable law, and that the CFTC has standing to sue persons for fraud in connection with spot sales of virtual currencies, even where such sales do not involve the sale of futures or derivatives contracts. The court, however, acknowledged that the CFTC’s oversight of spot virtual currencies is limited and not exclusive. Other regulators might include state and federal criminal authorities, the Department of Justice, the SEC, FinCEN, and the states.
Click here to access a copy of the relevant court decision.
In a February 13, 2018 letter to the Hon. Ron Wyden, Ranking Member of the Committee on Finance of the US Senate, the Treasury said that a developer or exchange that sells virtual currency, including in the form of ICO-issued coins or tokens, in exchange for another type of value that substitutes as a currency (e.g., virtual currency) is a money transmitter and must comply with FinCEN’s MSB requirements. Requirements include licensing as an MSB (unless, already registered with the SEC or CFTC or another qualified entity) and maintaining certain AML policies and procedures. AML obligations would also apply to SEC-registered broker-dealers and CFTC‑regulated introducing brokers or futures commission merchants that facilitate such transactions. The Treasury letter was released to the public on March 6.
Click here to access a copy of the relevant Treasury letter.
On March 7, the SEC again stated that a trading platform of digital assets which are securities and operates as an exchange must register with it as a national securities exchange or be exempt from registration, such as an alternative trading system under SEC Regulation ATS. Among other things, an SEC-registered national securities exchange must have rules to preclude fraudulent and manipulative acts and practices, and the authority to discipline its members for rule violations. (Click here for other similar SEC pronouncements in the article “SEC Obtains Emergency Asset Freeze to Stop Purportedly Fraudulent Initial Coin Offering” in the December 10, 2017 edition of Bridging the Week.)
Click here to access a copy of the relevant SEC advisory.
My View: Each of the federal court’s, FinCEN’s and the SEC’s views have support in applicable law. However, the potential of each of the regulators identified in the federal court’s opinion to regulate cryptocurrencies on an overlapping basis is a surefire way to impede development of decentralized blockchain technology and to squander limited public and private resources through parallel oversight by governments and the necessity of complying with multiple onerous state and federal regulatory requirements by market participants. The issue is not that the public should be well protected – it should and must be! However, beginning with the CFTC and the SEC, there should be (1) development of clearer guidance regarding which types of cryptocurrencies are likely securities and which are not in an effort to better delineate specific characteristics of each, as opposed to solely warn about possible overlaps, and (2) a finer tuning by the SEC of its application of the Howey standards to digital tokens issued in ICOs. (Click here for My View regarding the SEC’s application of Howey in the article, “SEC Sues Bitcoin-Denominated Trading Platform for Operating an Unlicensed Securities Exchange; Principal Criminally Charged in the February 25, 2018 edition of Bridging the Week.) This will better drive regulatory outcomes and minimize the chance of stifling overlapping oversight. Ultimately, however, Congress is also likely to have to get involved to help ensure there is no overlap in regulation where it should be sensibly avoided (or at least minimized) – much like Congress expanded the definition of a “commodity” in 1974 to afford the then newly created federal agency – the CFTC – exclusive jurisdiction over futures and options (and now swaps) on commodities.