Senior SEC Officials Provide Regulatory Clarity for Digital Assets

From Uncertainty toward Regulatory Clarity: Senior SEC Officials Provide Regulatory Clarity for Digital Assets

Summary is below, please click here for the full alert narrative.

On June 14, 2018, the Director of the Division of Corporation Finance of the Securities and Exchange Commission delivered a speech outlining the framework used by the SEC Staff in evaluating whether a given token sale qualifies as a securities offering.  The Director clarified that a token sale may qualify as a securities offering but subsequent sales of the same token may constitute non-securities based on a facts-and-circumstances analysis.  Later statements by the Chairman of the SEC and SEC Staff confirmed that the SEC will consider the factors outlined in the Director’s speech when evaluating token sales.  These factors include, among  other things, whether:

  • a sponsor or promoter’s efforts play a significant role in the development and maintenance of the token or token network;
  • a sponsor or promoter retains a stake or interest in the tokens such that the person or entity is motivated to expend efforts to cause an increase in value of the token;
  • purchasers are motivated by a financial return when purchasing the token; and
  • persons or entities other than the promoter or sponsor exercise governance rights or influence.

The SEC Director also commented that the SEC is “happy to help promoters and their counsel work through . . . issues . . . [and] . . . stand[s] prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.”

For questions regarding these developments and how they might apply to you or your business, please contact experienced counsel.

 

SEC Requests Comment on Bitcoin Futures ETFs

Updates: On June 15, 2018 the SEC extended its period of review for the Order (the “Extension”). The existing period of review was set to expire on June 24, 2018; however, under the Extension, the SEC has now extended its period of review by an additional 60 days until August 23, 2018. The SEC must now either approve or disapprove the proposed rule change by this new deadline.

On April 23, 2018, the SEC published a third order instituting proceedings to determine whether it will approve or disapprove another proposal for Bitcoin futures ETFs (the “Direxion NYSE Arca Order”).

On April 5, 2018, the SEC published a second order instituting proceedings to determine whether it will approve or disapprove another proposal for Bitcoin futures ETFs (the “Cboe Order”).

On March 23, 2018, the U.S. Securities and Exchange Commission (“SEC”) issued an order instituting proceedings to determine whether it will approve or disapprove a proposal for Bitcoin futures exchange-traded funds (“ETFs”) (the “Order”).

Commenters will have until April 19, 2018 to submit comments.  Those with rebuttals to the comments will have until May 3, 2018 to submit rebuttals.

Read more on our sister blog Derivatives & Repo Report

Ether is not a security: Summary of SEC Remarks Today

In a speech today during a crypto conference in San Francisco, a top Securities and Exchange Commission official expressed his view that, at this point, sales of Ether are not securities transactions. Speaking from prepared remarks, Bill Hinman, Director of the Division of Corporation Finance said: “Based on my understanding of the present state of Ether, the Ethereum network, and its decentralized structure, current offers and sales of Ether are not securities transactions.” Hinman also said that, in his view, Bitcoin is not a security either, reinforcing what SEC Chairman, Jay Clayton, stated in his remarks recently on CNBC.  The main topic of Hinman’s speech focused on whether a digital asset offered as a security can, over time, become something other than a security. To this point, Hinman noted that where a digital asset is “sold only to be used to purchase a good or service available through the network on which it was created . . . the answer is a qualified ‘yes.’” Hinman also discussed some of the factors to consider in assessing whether a digital asset is offered as an investment contract in a securities transaction. In particular, Hinman focused on the third prong of Howey and whether the efforts of an identifiable third party – be it a person, entity or coordinated group of actors – drives the expectation of a return. Also noteworthy was Hinman’s comment that the SEC is “happy to help promoters and their counsel work through . . . issues . . . [and] . . . stand prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.” Finally, in a footnote included in the written version of the remarks, Hinman, referencing SAFTs, stated his view that a token once offered in a security offering can, depending on circumstances, later be offered in a non-securities transaction.

Accounting Group Again Requests Guidance From The IRS on Virtual Currency Tax Issues

The primary professional organization for accounting professionals (AICPA) recently renewed their requests to the Internal Revenue Service for U.S. virtual currency guidance on key tax issues. The IRS has not shown any willingness to publish more advice in this area, so a response to the letter may not be forthcoming. The IRS has ignored the AICPA’s previous letter for 2 years now. That said, it provides thoughtful commentary, and recommendations for frequently asked questions, covering key topic areas including, among others:

  • Deductions for mining expenses
  • Acceptable valuation and documentation
  • Computation of gains and losses
  • Valuation for charitable contributions
  • Taxable and non-taxable events
  • Traders and dealers of virtual currency
  • Holding virtual currency in retirement accounts
  • Foreign reporting of virtual currency

Thus far, tax professionals have been forced to work from limited IRS guidance (Notice 2014-21), and informal public statements from government officials. The AICPA letter provides thoughtful ideas that reflect positions common among tax professionals. Their recent letter also reiterates a direct request from the ABA’s Tax Section for guidance on chain splits/hard forks (see American Bar Association Letter from March 2018).

ERC-721 Tokens Shake Up Blockchain Technology

The most prevalent tokens on the Ethereum blockchain are ERC-20-compliant (ERC-20 Tokens). However, there are many other ERC, or Ethereum Request for Comment, standards available. Recently, companies like Launch Labs, Inc. d/b/a Axiom Zen (Axiom Zen) have launched new endeavors utilizing ERC-721-compliant tokens (ERC-721 Tokens). ERC-721 Tokens each have unique characteristics, unlike fungible ERC-20 Tokens.

This post will discuss the rise of CryptoKitties, the exciting aspects of ERC-721 Tokens, and possible use cases for ERC-721 Tokens.

The CryptoKitties Revolution

Axiom Zen pioneered the ERC-721 standard for non-fungible tokens, which ultimately led to their application, CryptoKitties. CryptoKitties is an exemplary use case for how companies can utilize the ERC-721 standard. Each CryptoKitty is a ERC-721 Token that is one-of-a-kind and owned by the purchaser; it cannot be replicated, taken away, or destroyed. CryptoKitties can be purchased with Ether in descending-clock auctions. Owners can then “breed” the CryptoKitties, resulting in a completely new CryptoKitty, which is a new one-of-a-kind ERC-721 Token. The “genetic” makeup of the child ERC-721 Token is a combination of the genetic makeups of the two parent ERC-721 Tokens. The ERC-721 Tokens’ uniqueness allows for the creation of a whole new category of crypto creations. The ability for users to combine ERC-721 Tokens to generate completely new, but genetically traceable, ERC-721 Tokens allows for self-sustaining, growth-oriented networks.

What’s Next?

Since the birth of CryptoKitties, there are now over 100 CryptoKitty variants. Blockchain users can now buy, sell and trade a myriad of self-created digital collectibles, from cats to dogs to cartoons. While the proliferation of copycats (pun intended) does not show any signs of slowing, there are many other possible uses for ERC-721 Tokens. Below we discuss a few of those use cases.

Gaming

Many companies followed CryptoKitties into the blockchain game silo. New basic games are popping up around other digital collectibles, such as trading cards, which allow the movement of physical collectibles into the virtual space. These games and other CryptoKitty adaptations prove ERC-721’s utility in basic gameplay. But now there is room to see if the ERC-721 standard can be utilized on more sophisticated gaming platforms. Some smaller gaming companies recently started to create more comprehensive games and universes with ERC-721; however, the big gaming companies have yet to include this technology on their platforms. Nonetheless, we can see the potential opportunity to grow new gaming universes and expand or extend existing franchises utilizing ERC-721 Tokens.

Authentication

One of the touted promises of blockchain technology is the blockchain’s ability to ensure product authenticity. With ERC-721 Tokens, in conjunction with a blockchain, users can help prove non-fungible product authenticity. For example, if an art gallery owner encoded an ERC-721 Token into each gallery painting, the token could track everything from the painting’s original artist to its current owner. As a result, the token would allow artists to easily copyright their works. It would also ensure buyers that they own authentic products. ERC-721 is thus useful to individuals who want to protect their intellectual property and to individuals concerned about product authenticity.

Social Networks

ERC-721 Tokens allow for the creation of unique avatars, but at present there is no way for these avatars to interact, aside from breeding. Including a social interaction layer could dramatically increase the usability of the avatars and help enhance the growth of the ecosystem in which the avatars reside.

Moving Forward

We are at the forefront of not only a CryptoKitty revolution but also a ERC-721 revolution. Yes, ERC-721 offers application developers the ability to create fun, cute games. But, like other uses of blockchain technology, ERC-721 offers an opportunity to find solutions to complex real-world problems. As we push forward into the ERC-721 space, we must be cognizant of the endless possible uses for this new token standard.

We believe the future is bright for ERC-721 Tokens and we look forward to helping companies develop thriving businesses utilizing this token standard.

Blockchain in Review – Weeks of May 7th through May 25th, 2018

U.S. Developments

Regulatory Updates

CFTC Staff Issues Advisory to Exchanges and Clearinghouses on Virtual Currency Derivatives

On May 21, the Commodity Futures Trading Commission’s (CFTC) Division of Market Oversight and Division of Clearing and Risk released an advisory that provides guidance to designated contract markets (DCM), swap execution facilities (SEF), and derivatives clearing organizations (DCO) that offer derivatives with virtual currency underliers (the Advisory). The key take-aways are summarized below:

  • The Advisory notes that virtual currencies are distinct from other commodities because, although “serious, good faith efforts are underway to implement many potential uses of virtual currencies,” they are currently bought and sold primarily for investment rather than commercial purposes.
  • The Advisory deputizes DCMs and SEFs as spot market monitors. Platforms that wish to list virtual currency derivatives are expected to enter into information sharing agreements with the spot market exchanges that make up the cash-settlement price, continuously monitor data from these markets, and investigate individual spot market traders. This is novel. DCMs and SEFs are required to monitor the pricing of the index to which the derivative contract will be settled but not spot market trading for other commodities. DCMs and SEFs are expected to meet with the CFTC’s Division of Enforcement surveillance group regularly and provide CFTC staff with data upon request. This might better enable the CFTC to police fraud and manipulation in crypto asset spot markets.
  • CFTC staff recommends DCMs and SEFs set the threshold for filing large trader reports under Part 17 of the CFTC’s regulations at five bitcoin (or the equivalent for other virtual currencies) for virtual currency derivatives.
  • CFTC staff expects each DCM and SEF to engage CFTC staff and solicit comments prior to listing a virtual currency derivative contract. As part of its submission to the CFTC for listing of the contract, the DCM or SEF should provide an explanation of any opposing views raised by CFTC staff and how the DCM or SEF addressed them.
  • For cleared contracts, the Advisory explains that CFTC staff will request that DCOs provide information related to the governance process for approving virtual currency contracts.
  • CFTC staff may notify a DCM or SEF of its concerns in writing and make such writing public or transmit it to other regulators if it is unable to confirm that a contract submitted for self-certification complies with the CEA and CFTC’s regulations.CFTC Staff Advisory No. 18-14 5.21.18; CFTC Statement 5.21.18CFTC and NASAA Sign Mutual Cooperation AgreementCFTC Press Release 7730-18 5.21.18; CFTC Remarks 5.21.18CFTC Commissioner Behnam Emphasizes the Need for a Policy Roadmap for Regulation of FinTechCFTC Keynote 5.3.18SEC Statement Defining Financial Instruments by Function and Not Their FormSEC Speech 5.2.18Board of Governors of the Federal Reserve System Discussion on CryptocurrenciesFederal Reserve Speech 5.15.18Congress Holds a Hearing on Several Practical Applications for Blockchain Technology Committee on Science, Space, & Technology – Hearing 5.8.18
  • On May 8, the House Subcommittee on Oversight and House Subcommittee on Research and Technology held a hearing entitled “Leveraging Blockchain Technology to Improve Supply Chain Management and Combat Counterfeit Goods.” The panel included the following witnesses: (1) Dr. Douglas Maughan (Cybersecurity Division Director, Science and Technology Directorate, Department of Homeland Security (“DHS”)), (2) Robert Chiaviello (IPR Counsel, Nuby Law), (3) Michael White (Head of Global Trade Digitization, Maersk), and Chris Rubio (Vice President Global Customs Brokerage Staff, UPS). The hearing conducted an overview of various industry specific benefits associated with the use of blockchain technology. Dr. Douglas Maughan described DHS efforts to implement blockchain into boarder security programs and transportation networks. He emphasized the rapid pace of development of these systems and saw DHS implementations of blockchain technology as a promising method of furthering DHS objectives. In the private sector, witnesses were optimistic regarding the benefits of blockchain implementations for supply networks, particularly in their ability to identify counterfeit goods and improve logistics management. Chris Rubio, explained the use of blockchain technology as a means of digitizing physical asset information to provide real-time tracking, streamlining the flow of goods. According to Michael White, the U.S. is at the forefront of embracing blockchain technology, but he cautioned that the U.S. must remain open and neutral and strive for common global standards.
  • On May 15, Governor Lael Brainard of the Board of Governors of the Federal Reserve System appeared before the Decoding Digital Currency Conference to discuss the research being done at the Federal Reserve into blockchain technology. Governor Brainard emphasized that the Federal Reserve is evaluating developments in blockchain technology through a multidisciplinary lens, “combining information technology and policy analysis to study the potential implications for payments policy, supervision and regulation, financial stability, monetary policy, and the provision of financial services.” Discussion also turned to the topic of a central bank sponsored digital currency. She expressed skepticism regarding the possibility of a central bank digital currency due primarily to concerns associated with cybersecurity and money laundering risks. She also described the damage that the adoption of a central bank digital currency would have on bank operations due to the removal of depositary functions and the corresponding effect such removal would have on the loan market. The discussion concluded with Governor Brainard stating that she remains optimistic that the financial sector will find valuable ways to employ distributed ledger technology in the area of payments, clearing and settlement in coming years.
  • The Securities and Exchange Commission (SEC) Commissioner Hester M. Peirce appeared before the Medici Conference on May 2 to discuss blockchain tokens and the SEC’s role as a responsible regulator in this rapidly developing industry. The Commissioner described the various efforts the SEC is undertaking to better understand the challenges posed by distributed ledger technologies. The Commissioner also reiterated the SEC’s approach to treat cryptocurrencies based upon their function and not their form via a facts-based determination. Importantly, the Commissioner recognized several of the key challenges associated with analyzing various virtual currencies, including the question of whether a virtual currency could be a security at one point in time and then become some other instrument once the infrastructure surrounding the virtual currency is further developed. She closed her discussion by stating that although many questions remain open in the eyes of the SEC, she is confident that open communication between innovators and regulators could occur without the need for a government-sponsored regulatory sandbox.
  • On May 3, CFTC Commissioner Behnam spoke at the Futures Industry Association’s Law and Compliance conference about the regulation of FinTech. He stated that “policymakers . . . need to prioritize the discussions and policy roadmap for the oversight and regulation of FinTech.” Commissioner Behnam proposed that the U.S., through the Financial Stability Oversight Council (FSOC), lead the international effort to address legal issues related to FinTech and craft appropriate regulations before financial stability concerns arise.   He explained that “the FSOC has authority to (i) convene all key U.S. financial regulators; (ii) establish a mutually agreed lexicon for discussing crypto-assets and related FinTech; (iii) convene public hearings; and (iv) propose policy direction and guide jurisdictional responsibility based on input from regulators, stakeholders, academics, and the public.”
  • On May 21, the CFTC and North American Securities Administrators Association (NASAA) executed a mutual cooperation agreement. The agreement is intended to facilitate information sharing amongst the CFTC and state securities regulators and state attorneys general. CFTC Chairman Giancarlo noted that “with this MOU, we turn speech into action. As we discuss digital assets and the future, we must prepare for the present and future needs of oversight, law enforcement and consumer education. This MOU provides a much-needed resource for the CFTC and state securities authorities. It gives us scaffolding that builds upon a firm foundation for the future.”
  • Commissioner Behnam noted in a public statement that he remains interested in amending the regulations currently in place to bar self-certification of virtual currency derivatives in certain contexts. He stated: “I look forward to continuing to explore our options, which I hope will include some parameters for determining when self-certification may not be appropriate, and for determining when such matters are appropriately brought before the Commission.”

NY Department of Financial Services Approves Custody and Trading of Zcash, Litecoin, and Bitcoin Cash on Gemini

On May 14, the New York Department of Financial Services (DFS) authorized Gemini Trust Company, LLC to offer custodial services and trading of Zcash, Litecoin, and Bitcoin Cash. Notably, Gemini is the first New York licensed exchange to offer custody and trading of Zcash, a privacy coin.

DFS Press Release 5.14.18

NY Department of Financial Services Grants Virtual Currency License to Genesis Global Trading

On May 17, the New York DFS granted a virtual currency license to Genesis Global Trading, Inc. Genesis is the fifth company to receive a virtual currency license from DFS. Genesis is an over-the-counter crypto asset trading platform for institutional buyers and sellers.

DFS Press Release 5.17.18

Enforcement Update

Three Indicted In $25M Crypto Card ICO Fraud Scheme

On May 14, a federal grand jury in New York indicted three Florida residents with securities and wire fraud, based on allegations that they defrauded investors of $25 million by lying about their cryptocurrency debit card ahead of its initial coin offering (ICO). Robert Khuzami, deputy U.S. attorney for the Southern District of New York, said the three men sought to “capitalize on investor interest in the burgeoning cryptocurrency market.” The men allegedly made false claims about their products and relationships that they had with credible financial institutions including Bancorp, Visa and Mastercard. They also allegedly paid celebrities to promote their ICO, including musician DJ Khaled and professional boxer, Floyd Mayweather Jr. The criminal indictment came following several actions by the US Securities and Exchange Commission including civil charges brought last month. US Attorney SDNY Press Release 4.20.18

International Developments

Korean Government Agrees to Regulate Cryptocurrencies Under G20 Rubric

Top financial policymakers in South Korea, including the country’s Financial Supervisory Service (FSS), have agreed to recognize cryptocurrencies as financial assets and regulate them based on the unified regulations set forth by the G20 nations. This represents a reversal of South Korea’s position on cryptocurrency, which previously classified cryptocurrencies as non-financial products because of their perceived speculative value. Additionally, Korean regulators have agreed to adopt the standards of the intergovernmental Financial Action Task Force in revising its own policies. The G20 financial policymakers have set a deadline of July 2018 to make “the first step toward ‘unified regulation’ of cryptocurrencies.” China Money Network 5.18.18

Norwegian Banks Considering Issuing Digital Currency

The Central Bank of Norway announced in a working paper this month that it is considering developing its own cryptocurrency. Noting the decline in cash usage in the country, the report sets forth several uses and advantages of a digital currency issued by a central bank, including providing a “reliable alternative to deposits in private banks,” a solution for electronic payment systems, and an alternative method for bank customers to store financial assets.  Norges Bank Report 5.18.18

Zimbabwe Central Bank Bans Banking of Crypto

The Reserve Bank of Zimbabwe has directed all banks to refrain from providing banking services to anyone dealing with or settling virtual currencies, citing fears of money laundering and other criminal activity. Cryptocurrency exchanges are not affected by the ban for now. The ban is not expected to hinder peer-to-peer transactions; merely settling between banks. Reuters 5.14.18

Russian Justice Minister Takes Position that Cryptocurrency is Property

Which cryptocurrencies remain unregulated in Russia, the country’s Ministry of Justice has Alexander Konovalov has indicated that he considered cryptocurrency to be “other property” under the law and that digital coins should not be considered electronic money. Russia’s Civil Code does not mention “cryptocurrency” at all, but two drafts of legislation addressing cryptocurrency are pending in the lower house of the Russian parliament. One bill addresses this issue and would amend the Civil Code to include regulation of cryptocurrency payments; the second involves legalizing initial coin offerings (ICOs). Separately, a bankruptcy case involving Bitcoin holdings is pending in Russian courts that will determine whether cryptocurrencies have “real value” in Russia. Bitcoin.com 5.25.18

Taiwan Confirms New Regulatory Guidance on Cryptocurrencies is Forthcoming

The Justice Minister of Taiwan has reaffirmed the country’s plans to move ahead in passing new regulatory guidance on trading cryptocurrencies and has directed the new regulation to be in effect by November 2018. The goal is for Taiwan’s central bank, the Ministry of Interior, and the Bureau of Investigation to determine how each entity will regulate cryptocurrencies. A primary focus of the new regulation will be strengthening Taiwan’s AML rules. Asia Times 4.26.18

Philippines Permits Virtual Currency Operations in Special Economic Zone

In February, regulators in the Philippines legalized the entry of 10 virtual currency companies into an economic zone within the country. On April 25, the regulators gave permission for those companies to begin operations following licensure, which the economic zone regulator, CEZA, said would be forthcoming shortly. The central bank of the Philippines has not officially endorsed the use of any cryptocurrency. Reuters 4.25.18

Vietnam Directs Banks to Tighten Oversight on Cryptocurrency Activities

Following a crypto fraud resulting in the loss of 15 trillion Vietnamese dong ($658 million), the Vietnamese government issued a directive to six government ministries, in addition to financial institutions including Vietnam’s central bank, to tighten oversight and management of cryptocurrency activities within the country. The prime minister of Vietnam reiterated in a separate statement that transacting in cryptocurrencies remains illegal in Vietnam. Directive 4.11.18; Vietnam 4.11.18

Bitcoin Futures Volatility and Total Volume Since the Start of 2018

According to recent data provided by CBOE and CME Group, the volatility and total volume of bitcoin futures in 2018 have been in a gradual decline.  As displayed in the chart below, the Cboe bitcoin futures contract (XBT) volatility for the lead month declined in each month to begin 2018.  In addition, according to data as of a May 22, 2018 trading date, the trading volume for CME bitcoin futures contracts (BTC) in prospective lead months is also low, with as few as 5 trades for September 2018 contracts.  There have been a few instances of volume surges such as in late April when the average daily volume of XBT rose to 8800 in the single-most active session of the CBOE Global Market, according to CBOE.  However, as shown in the final chart below with data from CME Group as of May 22, 2018, the daily exchange volume of bitcoin futures contracts has remained below 6000 for the last month with one exception.

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Blockchain in Review – Weeks of April 21st through May 4th, 2018

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.

SEC Hinman Testimony 4.26.18; SEC Guidance 2018-22 on Cybersecurity 2.26.18

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

For additional International Updates, see Perkins Coie’s International Tracker.

Blockchain in Review – Weeks of April 4th through 20th, 2018

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.

International Developments

Bermuda Announces Proposed Regulation for ICOs and other Crypto-related Activity

The Bermuda Monetary Authority released proposed regulation for initial coin offerings (ICOs) and other virtual currency activities on April 13. The proposed legislation addresses ICOs in detail, which would require potential issuers of ICOs to apply for consent to operate from the Minister of Finance.  An application for consent would require the disclosure of information including corporate information of the entity planning the ICO, development and implementation plans for any product, service, or other project related to the ICO, amount intended to be raised through the ICO, timeline for the completion of the ICO, information related to the storage of identifying information of purchasers, and compliance and auditing protocols for token purchases.  Bermuda Monetary Authority Consultation Paper – April 2018

Malta Seeks Feedback on ICO Consultation Paper

On April 13, the Malta Financial Services Authority (MFSA) announced that it is considering moving ahead with introducing a “Financial Instrument Test,” which would clarify how the law defines digital assets and provide guidance to determine whether a blockchain-based asset would fall under EU regulation or Malta’s proposed Virtual Financial Asset Act (VFAA). The MFSA originally introduced the Test on November 30 in a paper addressing ICOs and other services related to virtual currency and tokens.  The April 13 consultation paper expands on the proposed Financial Instrument Test.  The government is seeking input from the financial services industry and the public, who can respond to the proposed regulation via a survey on the MFSA’s website. MFSA website – Consultation Paper and Survey

Singapore Remains Committed to Fostering Blockchain Initiatives

Singapore’s minister of finance, Hen Swee Keat, made opening remarks at the 22nd ASEAN Finance Ministers’ Meeting in which he indicated that Singapore would continue to support innovations in the FinTech industry and acknowledged the potential that distributed ledger technology (DLT) can provide for the country more broadly. Specifically, Minister Keat discussed the current pilot project between Singapore and Thailand, a project focused on regional “fast payments linkages,” which rely on DLT.  Although he did not provide details on other projects, Minister Keat indicated that Singapore is dedicated to exploring other blockchain initiatives that would facilitate financial transactions in Southeast Asia and lead to financial inclusion for underbanked areas in various countries in the region. Singapore Ministry of Finance Release 4.6.18

India and Pakistan Issue Warnings and Directives on Cryptocurrencies

In separate but similar statements, the Reserve Bank of India (RBI) and Pakistan’s central bank cautioned about the use of digital currencies in the respective countries. Both countries consider digital currency illegal.  The Indian government and RBI previously issued cautions to the public earlier this year about digital currency, in which they indicated a commitment to eliminate the use of digital currency in the country.  On April 6, the RBI began prohibiting banks from having any links to virtual currency businesses.  On the same day, Pakistan’s central bank reiterated that cryptocurrencies are illegal in the country and the government directed banks and other financial services providers to refuse customers seeking to transact in cryptocurrencies. Reuters article 4.6.18

UK’s Financial Conduct Authority Issues Statement on Cryptocurrency Derivatives

The Financial Conduct Authority (FCA), a financial regulatory body in the UK, announced on April 6 that companies offering cryptocurrency derivatives would likely require authorization from the FCA. Any company seeking to offer cryptocurrency derivatives would need to comply with applicable FCA rules and EU regulations.  The FCA does not currently regulate cryptocurrencies unless they are part of other regulated products or services; however, cryptocurrency derivatives could be considered financial instruments under the EU’s Markets in Financial Instruments Directive II (MiFID II).  According to the FCA statement, activities that will likely require FCA authorization include cryptocurrency futures, cryptocurrency contracts for differences, and cryptocurrency options. FCA Announcement 4.6.18

SEC Continues to Take Action Against Alleged ICO Fraud

On Monday, April 2, 2018, the U.S. Securities and Exchange Commission (SEC) charged two co-founders of Centra Tech, Inc. (Centra), a purported financial services company headquartered in Florida, with conducting a fraudulent unregistered initial coin offering (ICO) that raised more than $32 million from thousands of investors from July to October 2017.  In a parallel action, the two co-founders were separately charged and arrested by the U.S. Attorney’s Office for the Southern District of New York.

According to the SEC’s complaint, Sohrab “Sam” Sharma and Robert Farkas, the two co-founders of Centra, allegedly conducted a fraudulent ICO in which Centra offered and sold unregistered investments through a “CTR Token”—an ERC20 token on the Ethereum blockchain. The defendants allegedly claimed that funds raised in the ICO would help build a suite of financial products and provide benefits, including a “crypto debit card” backed by Visa and MasterCard that would allow users to instantly convert cryptocurrencies into fiat currency, as well as a “Centra token rewards program” that would entitle investors to a share in Centra’s future earnings.  In reality, the SEC alleges, Centra had no relationships with Visa or MasterCard.  The SEC also alleges that to promote the ICO, Sharma and Farkas allegedly created fictional executives with impressive biographies, posted false or misleading marketing materials to Centra’s website, and paid celebrities to endorse the ICO on social media.

The SEC’s action follows previous enforcement actions and public pronouncements that the SEC intends to take action against actors in the ICO space who fail to comply with federal securities laws, and in particular those who engage in fraudulent conduct.  Indeed, the SEC’s complaint specifically highlights the timing of the conduct at question—after the release of the SEC’s DAO Report of Investigation, which according to the SEC “warned the industry that digital securities can be, and often are, securities.”  The SEC’s investigation is ongoing, and the SEC acknowledged the assistance of the U.S. Attorney’s Office for the Southern District of New York, the Federal Bureau of Investigation, and the Financial Industry Regulatory Authority.  Read the SEC press release here.

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