OCC Moves Forward with Plans to Develop Bank Charters for FinTech Firms

The Office of the Comptroller of the Currency (“OCC”) announced today that it plans to move forward with considering applications from financial technology (fintech) companies to become special purpose national banks.  OCC Press Release from Dec. 2, 2016.  The OCC has concluded, among other things, that “applying a bank regulatory framework to fintech companies will help ensure that these companies operate in a safe and sound manner so that they can effectively serve the needs of customers, businesses, and communities, just as banks do that operate under full-service charters” and that “applying the OCC’s uniform supervision over national banks, including fintech companies, will help promote consistency in the application of law and regulation across the country and ensure that consumers are treated fairly.”  OCC, “Exploring Special Purpose National Bank Chargers for Fintech Companies” (Dec. 2016) (the OCC’s paper published concurrently with this announcement). The OCC derives its authority to issue charters for national banks and federal savings associations under the National Bank Act and the Home Owners’ Loan Act.  See 12 U.S.C. §§ 1 et seq. and 1461 et seq.  A special purpose national bank may limit its activities to fiduciary activities or to any other activities within the business of banking.  A special purpose national bank that conducts activities other than fiduciary activities must conduct at least one of the following three core banking functions: (1) receiving deposits, (2) paying checks, or (3) lending money. See 12 C.F.R. 5.20(e)(1). The OCC’s reading of this authority to issue charters to special purpose banks will  now extend to fintech companies that fit within the description of a special purpose bank.

Bitcoin Week In Review – December 2, 2016

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. 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

OCC Moves Forward with Plans to Develop Bank Charters for FinTech Firms
The Office of the Comptroller of the Currency (“OCC”) announced today that it plans to move forward with considering applications from financial technology (fintech) companies to become special purpose national banks.  OCC Press Release from Dec. 2, 2016.  The OCC has concluded, among other things, that “applying a bank regulatory framework to fintech companies will help ensure that these companies operate in a safe and sound manner so that they can effectively serve the needs of customers, businesses, and communities, just as banks do that operate under full-service charters” and that “applying the OCC’s uniform supervision over national banks, including fintech companies, will help promote consistency in the application of law and regulation across the country and ensure that consumers are treated fairly.”  OCC, “Exploring Special Purpose National Bank Chargers for Fintech Companies” (Dec. 2016) (the OCC’s paper published concurrently with this announcement). The OCC derives its authority to issue charters for national banks and federal savings associations under the National Bank Act and the Home Owners’ Loan Act.  See 12 U.S.C. §§ 1 et seq. and 1461 et seq.  A special purpose national bank may limit its activities to fiduciary activities or to any other activities within the business of banking.  A special purpose national bank that conducts activities other than fiduciary activities must conduct at least one of the following three core banking functions: (1) receiving deposits, (2) paying checks, or (3) lending money. See 12 C.F.R. 5.20(e)(1). The OCC’s reading of this authority to issue charters to special purpose banks will  now extend to fintech companies that fit within the description of a special purpose bank.

Court Rules IRS May Seek Information on Coinbase Customers
A federal judge in the Northern District of California ruled on Wednesday that the Internal Revenue Service can serve digital-currency company Coinbase with a “John Doe” summons seeking information on its customers’ transactions from 2013 to 2015. Order  The DOJ and IRS are investigating the use of bitcoin and the possibility that it has been used to evade federal tax laws over that three-year period.  The agencies do not have any proof of tax evasion, and there is no allegation that Coinbase engaged in any wrongdoing.

Coinbase issued a statement communicating its plans to oppose the government’s action and noted that it remains “concerned with our U.S. customer’s legitimate privacy rights in the face of the government’s sweeping request.” Coinbase Comment

States Seek Comments on Proposed Digital Currency Laws and Guidance
The Texas Department of Banking (“TDOB”) is proposing a new on-ramp to money transmission licensure for startup companies.  It has drafted a bill that would create a new subchapter of the Texas Money Services Act, which would provide a limited license to startups.  The new startup license would allow for low net worth and other relaxed requirements but would require involvement of an established license holder as a sponsor.  The TDOB has requested comments to be provided by December 2. Texas Money Transmitter Statute.

Similarly, the Illinois Department of Financial and Professional Regulation (“IDFPR”) has announced the release of the IDFPR’s proposed “Digital Currency Regulatory Guidance” for comment.  The proposed guidance expresses the IDFPR’s interpretation of the Illinois Transmitters of Money Act (the “Act”) and the application of the Act to various activities involving decentralized digital currencies. The proposed guidance also seeks to establish the regulatory treatment of such digital currencies under the existing definition of money transmission in Illinois as defined in the Act because currently, they do not fit the statutory definition of “money” and do not trigger the licensing requirements of the Act. The IDFPR will accept comments until January 18. Illinois Press Release

Recent DOJ Convictions for In-Game Virtual Currency
Last month, the Department of Justice convicted its fourth defendant in a scheme that defrauded a software company of over $16 million worth of virtual currency. Defendant Anthony Clark, 24, was convicted after a jury trial in Fort Worth, Texas. The DOJ presented evidence that the Defendant and three co-conspirators defrauded the software company Electronic Arts (“EA”)—publisher of a video game called FIFA Football.  Players of the game can earn “FIFA coins,” a virtual in-game currency generally earned based on the time users spend playing FIFA Football.  A secondary market for FIFA coins has developed, and coins can now be exchanged for US currency. The Defendant and his co-conspirators were convicted after circumventing multiple EA-developed security mechanisms and fraudulently obtaining FIFA coins worth over $16 million. All defendants await sentencing.  DOJ Release

 

International Developments

Uganda Takes Steps Towards Regulating Bitcoin
This past summer, a meeting on bitcoin and digital currencies was held in Kampala—aimed at building awareness of digital currencies and establishing a basis for Uganda to regulate bitcoin.  Should the effort move forward, Uganda would be one of the first African countries to regulate bitcoin.  The United Nations African Institute for the Prevention of Crime and the Treatment of Offenders recently released a report of this first meeting and the next steps.  Report

 

Britain’s Mint Plans to use Blockchain Technology for Gold Trading
The UK’s government-owned Royal Mint plans to use blockchain technology to operate a new gold-trading system. The Royal Mint is working with CME Group to develop a trading platform and to put $1 billion worth of gold on a blockchain sometime next year to allow customers to own and trade fractions of gold, stored in the Royal Mint’s vaults, using a digital token called Royal Mint Gold (RMG). Each RMG holds the value of one gram of gold.  The Royal Mint is accepting comments from wider market participants.  Royal Mint Announcement

For a comprehensive list of developments please see our Virtual Currencies: International Actions and Regulations.

 

Advertising Materials – Some jurisdictions in which Perkins Coie LLP practices law may require that this communication be designated as Advertising Materials.

Firm Headquarters: 1201 Third Ave., Suite 4900, Seattle, WA 98101

©2016 Perkins Coie. All Rights Reserved. Perkins Coie LLP

SEC Hosts First Ever FinTech Forum

On November 14, 2016, the SEC convened four panels of individuals at the forefront of the FinTech industry to address the rapid growth of recent innovations in FinTech. Panelists addressed how these innovations impact four main areas: investment advisory services; trading, settlement, and clearance activities; capital formation; and investor protection. The over-arching theme of the forum was the overlay of financial regulation in the rapidly-changing securities industry and how regulation needs revision to better address emerging technologies. Below we have summarized the four panels and the key take-aways.

Investment Advisory Services

Investment advisers have a fiduciary duty to act in their clients’ best interests. Over the last 2-3 years, investing services have largely evolved to include digital wealth managers (“robo-advisers”), which were created in an effort to meet higher standards of client service by making better, smarter, and more sophisticated investment decisions. There has been huge growth in investment management for smaller account sizes over the last few years, thanks in no small part to robo-advisers providing greater access to the market.

Despite the misnomer, robo-advisers are simply financial advisers who make greater use of available technology by automating certain tasks. They are registered with the SEC as advisors and are subject to the Investment Advisers Act of 1940. Individual (human) advisers remain in control of inputting data, identifying algorithms, and assigning investment strategies. The goals of robo-advisors are the same as traditional financial advisers: to protect investors from unwanted risk and volatility, to maintain fair and orderly investment markets, and to facilitate capital investment, all while maintaining a high duty of care as fiduciaries. Far from a “set it and forget it” model, robo-advisers customize each investor’s portfolio and make custom investing decisions for each client. Algorithm design and oversight are important, as flaws in algorithms remain one of the biggest risks.

Robo-advisers have improved investing in several important ways:

1. Taking the workload off of individual consultants, allowing firms to serve more clients. Traditionally, an adviser would talk to a client one-on-one to explain the rationale of investment decisions. Now, clients can access their investment portfolio in real time without having to pick up a phone. Conversations that do take place between clients and advisers have become much more interactive.

2. Bringing in new investors with lower assets under management (AUM) to provide them with basic financial advisory services. Individuals who previously led largely unexamined financial lives now have greater access to markets. Robo-advisors are especially appealing to tech-savvy millennials, as new investors. (The average age of a digital wealth client is 35.) Robo-advisors also make investing much more approachable for individuals who previously couldn’t afford investment advice. The industry can now serve more people than under the less scalable service models that have existed historically.

A real-world application of robo investing is in the looming retirement savings crisis, whereby individuals might not be able to rely on social security when they reach retirement age. Consequently, personal investment portfolios will be extremely important to maintain for an increasing number of people. Individuals (especially un-savvy investors) will need to be advised, not simply given a supermarket of securities to buy.

3. Improved client service at all levels of investing. Robo-advisers service a range of investors. The Vice Chairman of Personal Capital estimated that 1/3 of the company’s assets are held among households managing over $1 million. These more sophisticated higher-net-worth investors benefit from new technologies, with more simplicity and efficiency. All accounts are in one place, so a client can see spending and investments side-by-side.

4. Greater transparency. Robo-advisers maintain high levels of disclosure standards. Clients can see what the wealth manager is doing–that is, how and why investments are being made. One great benefit of using algorithms is that they are highly visible, allowing a client to see if any advice he/she is getting is in conflict. Full and fair disclosure of material information is critical, particularly with respect to higher-yield riskier investments.

Robo-advisors need to be regulated differently, and regulators need to keep pace with the associated technologies.

Trading, Settlement, and Clearance Activities

Distributed ledger technology (DLT)–one of the signature characteristics of blockchain–will be a major disrupter to the financial services industry, changing the way the financial sector thinks about and handles post-trade processes. The major driving force for companies has been cost-savings, but these decentralized databases offer additional benefits to the industry including improved efficiency, speed, and transparency. Whereas cryptocurrencies like Bitcoin rely on an open-access distributed ledger, clearing and settlement networks like Bankchain use permissioned, privately-shared distributed ledgers.

Companies and stock exchanges are increasingly relying on distributed ledgers. NASDAQ uses blockchain as an alternative to recordkeeping and data warehousing. In 2017, the Australian Stock Exchange Group (AGX) will begin building a system for cash equities that relies on DLT.

The SEC announced that it has a dedicated Distributed Ledger Technology Working Group focused on blockchain regulation and how to keep pace with DLT and address the emerging risks. Cybersecurity is of chief concern to regulators as distributed ledgers become more mainstream, but DLT actually offers superior transparency and reduction of systemic risk than traditional exchanges. Other benefits of DLT have been realized by regulators, who can rely on algorithms to provide better access to transaction-level data to facilitate audits.

Capital Formation

Increased regulation has made traditional bank lending difficult, and there is a serious lack of access to capital for small businesses and individuals looking to raise $150,000 or less. Online marketplace lending and securities-based crowdfunding both provide robust opportunities and solutions for small businesses seeking access to capital. Sadly, the existing infrastructure for capital formation is antiquated and broken, with industry leaders expressing a great deal of frustration and placing the blame squarely on the SEC and other regulatory agencies.

Marketplace lending relies on algorithms and other technology to evaluate borrowers. Assessing risk is one of the main challenges for the current data and analytics. But far from being a behind-the-scenes operation, lending firms are deeply committed to loan-level disclosure and transparency, allowing lenders to evaluate and minimize risk themselves. Marketplace lending has the opportunity for enormous growth, and increased competition will continue to benefit consumers and small businesses by creating downward pressure on interest rates. Collaboration between banks and marketplace lenders will prove hugely beneficial going forward.

Crowdfunding has become another hugely successful method of raising capital, and it exists on many platforms including Kickstarter, GoFundMe, and Indiegogo. But crowdfunding platforms continue to face obstacles because of regulatory uncertainty. Inconsistencies in state and federal regulations remain one of the biggest obstacles to crowdfunding platforms. Regulators’ failure to clarify those inconsistencies have left the United States behind in innovation regarding capital formation, particularly with respect to digital and mobile-based lending.

Investor Protection

The most pressing issue for investors is trust, which is at the core of investment capital. No trust = no investment.
Consequently, investor protection is a top priority in the FinTech industry.

Protecting investors means keeping them well-informed. Industry leaders and regulators agree that investor access to information is paramount. Investors want to be able to see the information that is relied upon to make investment decisions. Innovations in FinTech have greatly improved the quality of data and have streamlined the processes for making relevant data available to customers. The common denominator in how companies provide better customer service is technology-driven innovation, which has raised the bar for customer service across the financial industry.

Another critical aspect in protecting investors is increasing cybersecurity and protecting the data that investors rely on to make decisions. Effective cybersecurity in the realm of compliance involves:

1. Monitoring for cyber intrusion;
2. Preventing intrusion by controlling access; and
3. Responding to cyber-attacks.

A lot of innovation has taken place most recently in the area of responding. Companies like Target who are victims of security breaches must be prepared to address the problems appropriately. Target did not, and they suffered. Dedicated cyber security advisors emphasize the importance of responding to security breaches correctly: Identifying the cause of the breach, and proposing solutions for more robust safety measures going forward. Every company should have a plan for hardening cybersecurity.

Innovators and regulators have the shared goal of inspiring trust in the market by improving disclosure and maintaining a high level of cybersecurity. How best to achieve these goals is still the subject of debate. Regulators are quick to note that regulations offer not only protection to investors, but contribute to investor confidence in the market. Companies argue they have strong incentives (even absent regulations) to continuously improve data access and security, which in turn inspires investor trust and protection.

Conclusions

FinTech is no longer just a term, but a movement that drives innovation across financial markets. Companies in the FinTech industry are always innovating, offering new technologies and platforms to better service their clients. As one forum panelist noted, there is virtually one new FinTech idea every week. In its early stages, FinTech included technology like ATMs and has now grown to include highly sophisticated blockchain technology, data aggregators, and new approaches to data mining.

And as FinTech transforms the financial industry across the board, from high-level investing to small peer-to-peer payments, it challenges existing norms, and faces regulatory hurdles. The SEC and other regulatory agencies have found themselves in a position of playing catch-up, trying to tailor old regulations to rapidly emerging new technologies, which is often unhelpful. Alternatively, regulators are attempting to implement revised regulations and guidelines that directly address new technologies. Unfortunately, the response has been sluggish. Regulations have not kept up with many innovations, to the great frustration of companies trying to implement those innovations. This lack of revised regulation is perhaps even worse than over-regulation because it makes innovators uncertain about how new technologies will fare. A company would certainly not want to sink millions of dollars into a new innovation, only to have it shut down by the SEC. Bolder companies like Uber and Airbnb have forged ahead, often finding themselves in positions of asking for forgiveness, rather than permission, when they fall afoul of regulations.

A proposed solution has been to build a “regulatory sandbox” in which companies would be allowed to experiment with new products in a controlled space with a limited number of consumers. This plan has many benefits, and has overwhelming support of the industry. Other countries like the UK and Singapore have rolled out similar regulatory sandboxes, but regulators in the United States have so far shut down this possibility, leaving the US woefully behind in this respect. Industry pushback has been swift, criticizing regulators for stymying innovation.

Among the challenges to regulators is striking the right balance between fostering innovation while ensuring new technologies and products aren’t rushed to market prematurely in a way that facilitates data breaches, increases risk of fraud, or otherwise harms investors. This will require regulators to recommit themselves to staying informed about new technologies in order to propagate comprehensive and forward-looking regulations. Regulatory complexity will continue to exist, presenting greater opportunities for providers of Regulatory Technology (RegTech), as they help companies come into compliance and enhance risk assessments, all while remaining innovative. Ultimately, the SEC will continue to largely determine how FinTech will function.

Bitcoin Week in Review – November 11, 2016

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. 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

 

Uniform Law Commission
Over the past year, the nonprofit Uniform Law Commission (ULC) has been steadily working to draft legislation meant to harmonize state laws focusing on the regulation of bitcoin and other digital currencies. The ULC’s drafting committee most recently met October 28-29, 2016 in Minneapolis, and could be prepared to vote on a such a draft by the end of next summer.  The latest draft of the ULC’s model legislation is available here.

State regulators and legislatures would ultimately have to adopt the ULC’s proposal (or incorporate some of its suggestions piecemeal) before any of the provisions can be enforced.

Despite the ULC’s harmonizing attitude, a number of states have separately pursued a proactive approach towards digital currency regulation, either by bringing digital currency regulation under existing state statutes (as in North Carolina), or by drafting regulations from scratch (as in Florida, and most notably, New York).

IRS Inspector General
Two and a half years after the IRS first declared its intention to oversee and tax digital currency transactions, the Inspector General of the IRS warned that there is little evidence that the agency took the steps necessary to deliver on its broad strategy.

In 2014, an IRS policy release proposed to tax bitcoin as a kind of property and to help taxpayers voluntarily comply with their tax obligations for retail purchase transactions related to (but not necessarily made with) virtual currencies. The policy was intended to help the IRS close the tax gap surrounding virtual currencies by bringing these kinds of transactions under the agency’s supervision.

The Inspector General’s report noted that agency had failed to implement its strategy, in part, because the IRS had failed to provide adequate information to help taxpayers voluntarily comply with their tax obligations, and had failed to respond to the proposals and questions made via public comment.

As a consequence, the report noted that “until a comprehensive virtual currency tax strategy is developed, the IRS is open to the risk that undetected noncompliance of virtual currency taxable transactions will result in an increase to the Tax Gap.”

The Inspector General’s report concluded by identifying management oversight and internal controls as two potential solutions to ensure that the strategy is properly developed and implemented.

International Developments

 

Senegal
This week, Senegal became the second nation in Africa to issue its own national digital currency (Tunisia was the first). The currency, dubbed the eCFA (electronic Central African Franc), was developed in partnership between ECurrency Mind Limited and Banque Regionale des Marches, and issued in compliance with the e-money regulations of the Banque Centrale des Etats de l’Afrique de L’Ouest (the central bank of the Western African Economic and Monetary Union).

In contrast to other virtual currencies like bitcoin, the eCFA is considered a fiat currency because it is both backed by a central bank and because its value will be kept at parity with its physical counterpart, the CFA Franc. Although only authorized financial institutions can issue this new e-currency, it remains unclear how the central bank will keep track of the coins and what level of cryptography will prevent the coins from being counterfeited or compromised.

Switzerland
Last week, the Swiss Federal Department of Finance (FDF) outlined its plan to regulate fintech with the aim of introducing draft legislation to parliament by mid-2017 after a public consultation. The plan’s stated aim was to help the country draw in more fintech companies by virtue of an accommodative stance aimed to reduce barriers to market entry for fintech firms.

The FDF’s plan will make the Financial Market Supervisory Authority the primary regulator of fintech firms working in Switzerland. The plan also called for the creation of a new license to be created specifically for fintech companies along with a regulatory “sandbox” for experimental firms.

European Union
The European Parliament’s latest proposed budget includes both language and funds for the creation of a dedicated task force focused on the uses and risks associated with digital currencies. As proposed, the working group will develop a regulatory framework for the economic block, helping the EU boost its institutional knowledge of the technology while also exploring the technology’s possible applications for government.

The task force will be “staffed with regulatory and technical experts, in order to build up technical expertise, regulator’s capacity and develop uses cases, especially for governmental applications, in the field of distributed ledger technology.” Before the measure goes into effect, the budget proposal is subject to debate and final approval by the European Commission.

Australia
This week, the Australian Attorney General’s Department published a consultation document outlining the Government’s intention to revise the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act, or the Act) to incorporate regulations relating to convertible digital currencies, with an emphasis on those activities undertaken by digital currency exchange providers. Proposed revisions include amendments to ensure that new digital wallets which store digital currency are comprehensively captured by the scope of the AML/CTF Act. Similarly, the Act’s definition of e-currency would be expanded to include digital currencies which are not backed by a physical commodity, with strategic carve outs for non-convertible digital currencies that pose a low risk of being used in money laundering schemes.

Drafts of the proposed legislation are expected to begin by the middle of 2017, with a stated aim of openly soliciting and incorporating public comment. The legislation is expected to be completed by 2018.

Although the announcement clarified a rough timeline for the publication of the revised law, it failed to indicate how the new law might be drafted or what kinds of companies and currencies might be targeted.

The Australian government’s attention to fintech has been steadily increasing. Prior to this week’s publication, the Australian government’s most recent fintech announcements have included proposals to reduce the tax burden on imposed bitcoin activity and create an overarching legislative framework to govern how the country’s financial industry might begin to integrate block chain technology.

For a comprehensive list of developments please see our Virtual Currencies: International Actions and Regulations.

Could Blockchain Push Syndicated Loans over the Regulatory Edge?

Banks are exploring using blockchain to increase the efficiency of trading syndicated loans. The hope is to increase the liquidity and transparency of the secondary market for loans. The risk is that their efforts will be so successful that the loans may lose their historical exemption from the registration and anti-fraud provisions of the Securities Act and Securities Exchange Act.

“Could Blockchain Push Syndicated Loans over the Regulatory Edge?” is a cross post from the firm’s Asset Management ADVocate blog. The post explores steps that might be taken in designing a blockchain system that might prevent syndicated loans from being characterized as “securities” under federal laws.

Cryptocurrency Platform Provider Seeks No-Action Relief from CFTC: Two Observations

On October 18th, a cryptocurrency platform provider (Poloniex, Inc.) issued a press release announcing that it filed a request for no-action relief with the Commodity Futures Trading Commission (the “CFTC”) seeking request with respect to the CFTC’s laws as they relate to margin and lending transactions. To our knowledge, this is first time that a cryptocurrency platform provider has publicized the submission of such a request and, for that reason alone, the development is noteworthy. A detailed review of the request or underlying law is beyond the scope of this posting. Rather, in this posting we focus on what we consider to be two practical and fundamental observations regarding the potential scope of any hypothetical relief granted in response to such request. Hypothetically speaking, if the CFTC granted the requested relief in the manner presented by the platform provider, then such relief would seem to support the following two interpretations of section 2(c)(2)(D) of the CEA:

1.A platform provider could facilitate a leveraged, margined or financed transaction in respect of a commodity, as long as the underlying commodity is delivered to the purchaser within 28 days. Under such an interpretation, the leverage, margin or financing could arguably remain in place subsequent to the delivery of the commodity without the transaction being subject to regulation by the CFTC. In considering this hypothetical interpretation, we note that section 2(c)(2)(D)(i) of the Commodity Exchange Act (the “CEA”) appears to give the CFTC jurisdiction to regulate the offer of a retail commodity transaction without regard to whether or not the contract is entered into by the parties; and

2.A platform provider would be able to facilitate the ultimate settlement of leveraged, margined or financed cryptocurrency transactions into the platform provider’s digital wallet in a manner that constitutes “actual delivery” for purposes of the exception under section 2(c)(2)(D)(ii)(III)(aa) of the CEA, as long as: a) the platform provider establishes a sub-account on behalf of each platform subscriber; and b) records ownership of the cryptocurrency by the subscriber in that sub-account. We note that this hypothetical interpretive position would appear to be a different approach to the application of the requirements of section 2(c)(2)(D) to settlement into digital wallets from the approach that was presented in a June 2016 CFTC enforcement matter involving Bitfinex. Please see our posting, Making Sense of the CFTC’s Enforcement Order and Settlement with Bitfinex. In particular, in that June 2016 order and settlement, the CFTC took a position that, in the facts and circumstances of that matter, the accounting for individual customer interests in the bitcoin held in an omnibus settlement wallet in platform provider’s own database was insufficient to constitute “actual delivery” for purposes of the exemption from regulation as a retail commodity transaction under section 2(c)(2)(D). In this regard, it is also noteworthy that the CFTC indicated that actual delivery would not occur if a platform provider retained control over the private keys to individually enumerated multi-signature wallets in a situation in which the platform customer lacked a contractual relationship with the third-party firm that established the wallets. Finally, it should also be noted that there appear to have been liens recorded against the wallets that contained the bitcoin under the facts of the June 2016 enforcement order, whereas the platform provider that requested the current no-action relief does not appear to have a lien against the bitcoin in the customer’s account. Although, there is still margin posted by that customer subsequent to the transfer of the bitcoin to the purchaser and, presumably, there is a lien against that margin. In closing, it is readily acknowledged that factual considerations may distinguish a digital wallet offered by one platform provider relative to the digital wallet offered by another platform provider, and that such considerations are important to consider as part of any regulatory analysis.

Obviously, a request for relief does not obligate a regulatory agency to issue the requested relief. So, the impact of the request is largely an “unknown” at this point. Nevertheless, the requested relief presents an opportunity for significant regulatory “navel gazing” about what it could mean if the CFTC were to grant that relief.

Good day. Good “regulatory navel gazing”? DR2

ETF Corner: SEC Requests Comment on listing of Bitcoin ETF

On October 12, 2016 the Securities and Exchange Commission (“SEC”) issued an order instituting proceedings to determine whether or not to approve or disapprove a proposed rule change filed by Bats BZX Exchange, Inc. (“Exchange”) that would permit Winklevoss Bitcoin Shares (“Shares”) issued by the Winklevoss Bitcoin Trust (“Trust”) to be listed and traded on the Exchange. The SEC is instituting proceedings “in the view of the legal and policy issues raised by the proposed rule change” and stated that such proceedings “does not indicate that the Commission [SEC] has reached any conclusions with respect to any of the issues involved.” As further noted below the SEC is encouraging “interested persons to provide comments on the proposed rule change.” Continue Reading

Bitcoin Week in Review – 10.01.16 – 10.14.16

Below is a summary of some of the significant legal, regulatory and industry actions that occurred over the past week. 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 Developments

CFPB Declines to Make Definitive Statement on Virtual Currencies in Final Prepaid Account Rule

On October 5th, after more than four years of anticipation by the financial services community, the Consumer Financial Protection Bureau (CFPB) issued its final rule concerning prepaid accounts, declining to make any definitive statement as to whether Bitcoin and other virtual currencies fall within the scope of Regulation E. Regulation E implements the Electronic Fund Transfer Act and provides certain consumer protections by law, such as those relating to lost or stolen cards and restricting liability for unauthorized transactions. For the time being, this is welcome news for digital currency advocates who feared the negative impact of regulating “virtual currencies” as a prepaid financial account. Nonetheless, fiat prepaid accounts and digital wallets are in scope, and such platforms are advised to confer with counsel as to its applicability to their particular business. The final rule will take effect on October 1, 2017.

SEC Delays Decision on Bitcoin ETF

The SEC has further delayed a decision on approving the SolidX bitcoin exchange-traded fund (ETF). The proposed fund, if approved, would be the first exchange-traded product available on U.S. markets to hold a digital asset such as bitcoins. Instead, the SEC has implemented another three-week comment period to seek additional feedback on: the stability, resilience, fairness and efficiency of bitcoin markets; the potential for losses via computer hacking and manipulation; the product’s valuation method; and whether bitcoin’s “novel and unique properties” make it “an appropriate underlying asset for a product that will be traded on a national securities exchange.” The new deadline for the SolidX bitcoin ETF decision is October 31, 2017. We encourage participation on the proposal, and thus far the SEC has only received six letters for and against bitcoin ETF.

Industry Developments

Credit Unions Turn to Blockchain

Faced with increasing competition and declining numbers across the credit union industry, Credit union service organizations (CUSOs) are joining more than 60 credit unions in the CU Ledger blockchain initiative, in an attempt to develop applications for distributed ledger technology (DLT) in the industry. The initiative is primarily focused on utilizing smart contracts and developing a user-centric digital identity that could enable faster authentication while minimizing fraud, and is funded by participant fees with a minimum investment of $10,000 required to participate. CU Ledger has the support of the system’s largest CUSOs and is working with Salt Lake City-based start-up Evernym in the hopes of having a prototype up and running by early next year.

Central Banks Look to Blockchain

Central banks are paying increasing attention to distributed ledger technology (DLT) and its potential to make the financial system faster and more efficient, transparent and secure. In a speech on October 7th, Federal Reserve governor Lael Brainard acknowledged the technology’s potential to transform the financial system, saying, “We are paying close attention to [DLT], recognizing this may represent the most significant development in many years in payments, clearing and settlement.” Her speech came just three days after the Fed announced the launch of a major new study on digital payment technologies, bitcoin, and fintech more broadly, to be led by the Fed’s Faster Payments Task Force. The study will focus primarily on the security and implementation of faster payments technology in order to encourage widespread adoption by businesses and consumers when the technology becomes available. The Fed’s effort is also designed to catch up to other countries who are further along in bringing their payments systems into an increasingly digital landscape — notably, the Bank of England, the People’s Bank of China, the Monetary Authority of Singapore and the Reserve Bank of Australia. The Bank of Russia also recently announced that it was testing Masterchain, an Ethereum-based blockchain prototype.

International Developments

Virtual Currency Regulation Takes Effect in “Bitcoin Isle”

Light touch regulation of virtual currency exchanges have come into effect on the autonomous island of Jersey in the UK. The new laws make virtual currency exchange a supervised business and require exchange businesses with an annual turnover threshold of £150,000 or more to register with the Jersey Financial Services Commission (JFSC). Digital currency service providers will be sanctioned if they fail to register within three months of crossing that threshold.  The new laws are designed to encourage experimentation, innovation and testing of new virtual currency products, services, business models and delivery mechanisms, while balancing the need for regulation.  They also build on prior Jersey governmental efforts to attract companies involved in Bitcoin and other fintech services.  In 2014, for instance, the island became home to the first ever regulated Bitcoin fund, Global Advisors Bitcoin Investment Fund (GABI), which was certified by the JFSC and allows traditional investments such as pensions to be invested in Bitcoin and secured by the same security features in commonly used financial products.  And today, according to a local Bitcoin advocacy group, sixteen establishments on the tiny island accept Bitcoin as a method of payment.

Dubai Aims to Have All Documents on a Blockchain by 2020

On October 5th, the Crown Prince of Dubai announced a strategic plan to have all government documents secured on a blockchain by 2020, as part of a larger initiative known as the Dubai Future Agenda, whereby Dubai aims to set the standard for “smart cities” of the future. The plan, known as the Dubai Blockchain Strategy, has three main pillars: government efficiency, industry creation, and global leadership, and is a joint project between the Dubai Future Foundation and Dubai Smart City Office. The Dubai government estimates its blockchain strategy has the potential to generate 25.1 million hours of economic productivity each year in savings, while reducing CO2 emissions. If successful, individuals would only need to enter their personal data or business credentials once, after which the information would be updated and verified in a timely manner through the blockchain network across all government and private entities, including banks and insurance companies. The Crown Prince also announced plans to open the platform to other cities and nations in the hopes of international collaboration in the future.

For a comprehensive list of developments please see our Virtual Currencies: International Actions and Regulations.

Bitcoin Week in Review

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. 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

OCC Proposes Rollout of a Limited-Purpose FinTech Charter
Earlier this month, the Office of the Comptroller of the Currency (OCC) released a notice of proposed rulemaking, which among other things, paves the way for the OCC’s rollout of a special purpose financial technology (FinTech) banking charter.  See  81 Fed. Reg. 62835 (proposed Sept. 13, 2016).

Under this proposed rulemaking, the OCC would be able to act as a receiver for national banking institutions that are not insured by the Federal Deposit Insurance Corporation (FDIC) (uninsured banks).  The OCC supervises very few uninsured banks, and currently, all such banks are special purpose trust banks whose operations focus on fiduciary and custodial operations.  But under federal law, the OCC may also charter other special purpose banks, so long as they conduct at least one of the three core banking functions (receiving deposits, paying checks, or lending money).   As part of its initiative on responsible banking innovation, the OCC is expressly considering “whether a special purpose charter could be an appropriate entity for the delivery of banking services in new ways,” which may include use of financial technology.  With the prospect of “fintech” special purpose banks in mind, the OCC is seeking comment on whether its proposed receivership rule would work for such banks.

The OCC invites comments on the proposed rule, which should be submitted by November 14, 2016.  OCC News Release (Sept. 13. 2016).

Congress Forms a Bipartisan Blockchain Caucus
Rep. Mick Mulvaney (R-SC) and Rep. Jared Polis (D-CO) announced the formation of a new bipartisan Congressional Blockchain Caucus on Monday, September 26, 2016.  See  Polis launches Congressional Blockchain Caucus Press Release (Sept. 26, 2016).   According to Rep. Polis’s press release, this caucus will be dedicated to advancing sound public policies related to cryptocurrencies and other blockchain-based technologies.  It will also seek to educate, engage, and provide research to help policymakers implement smart regulatory approaches to the issues raised by blockchain-based technologies and networks.

New Hampshire Commission to Study Cryptocurrency Holds First Publically Attended Meeting
New Hampshire held a public meeting Wednesday (9/28/2016) to discuss whether to move forward with regulatory action for companies that sell and exchange bitcoin and other virtual currency.  This discussion is in response, at least in part, to New Hampshire’s newly amended banking laws that included virtual currency into the banking regulatory fold as of January 1, 2016.  See  NH Revised Statutes § 399-G:1 (effective Jan. 1, 2016).  Although several companies have registered as money transmitters with the state banking department—another company has announced plans to withdraw from serving New Hampshire residents in October. See David Brooks, State’s banking regulations have NH bitcoin community rattled, Granit Geek, available at Granite Geek (posted Sept. 28, 2016). Attendees of the meeting report that most participants—including the meeting’s chairman, Representative John Hunt of Rindge—were opposed to enacting any regulations.  On the other side of the aisle, the New Hampshire Banking Department representative Maryam Torben-Desfosses, expressed support for regulation. The commission’s ultimate goal is to reach a recommendation either for or against regulation of cryptocurrency in New Hampshire.  The commission will hold its next meeting on October 6th at 10 a.m. in the Legislative Office Building in Concord, NH. Video of NH Hearing

International Developments

British Crown Dependency Channel Isle of Jersey’s Legislature Approves Plan to Regulate Digital Currency
The State Assembly in Jersey’s legislature (the largest of the Channel Islands) published a government order effective September 26, 2016 to regulate anyone operating as a digital currency exchange.  See Jersey Government Order (Sept. 23, 2016).   This legislation is designed to provide a registration system for certain service providers and to avoid a full-on licensure scheme (like the New York BitLicense).  See, e.g., Island of Jersey wishes to regulate bitcoin technology without impeding its development, CoinFox (Oct. 21, 2015), available at Coinfox.com.  The Order exempts anyone operating as a digital currency exchanger from requirements to register their business with the government if their annual business carried on by a person (“turnover”) is less than ₤150,000.  Digital currency exchanges that exceed that threshold have three months to register their business.

For a comprehensive list of developments please see our Virtual Currencies: International Actions and Regulations.

SDNY Opinion re: Bitcoin

U.S. District Judge Alison Nathan of the Southern District of New York issued a decision yesterday finding that bitcoins are money under the plain meaning of Section 1960, the federal money transmission statute. In July 2015, Anthony Murgio and two others defendants were arrested and charged with operating an illegal bitcoin exchange – Coin.mx. Murgio sought to dismiss two counts – operating, and conspiracy to operate, an unlicensed money transmitting business. He argued that virtual currency falls outside the definitional scope of the applicable statute. The court disagreed.

Section 1960 makes it a crime to knowingly conduct, control, manage, supervise, direct, or own all or part of an unlicensed money transmitting business. The statute defines money transmitting to include transferring funds, and lists three ways in which a “money transmitting business” can be deemed “unlicensed.” First, a money transmitting business is unlicensed if it is operated without an appropriate money transmitting license in a State where such operation is punishable as a misdemeanor or a felony. Second, such a business is unlicensed if it fails to comply with federal money transmitting business registration requirements. And third, a money transmitting business is unlicensed if it involves the transportation or transmission of funds that are known to the defendant to have been derived from a criminal offense or are intended to be used to promote or support unlawful activity.

Section 1960 does not specify what constitutes “transferring funds.” This raises the question of whether bitcoins are deemed to be “funds” or money under the statute. The court concluded that they are. Relying on two prior decisions – Judge Rakoff’s decision in United States v. Faiella, 39 F. Supp. 3d 544, 545 (S.D.N.Y. 2014) and Judge Forrest’s decision in United States v. Ulbricht, 31 F. Supp. 3d 540, 570 (S.D.N.Y. 2014) – and applying the “ordinary meaning” of the term “funds,” the court stated that:

bitcoins can be accepted as a payment for goods or services or bought directly from an
exchange with a bank account. They therefore functions as pecuniary resources and are
used as a medium of exchange and a means of payment.

Hence, the court held that bitcoins are “funds” under the statute.

While the publicity surrounding this decision may seem noteworthy, in reality the court’s decision is consistent with several other federal cases and will unlikely have a dramatic impact.

LexBlog