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.
CFTC and SEC Enforcement Directors Issue Joint Statement Regarding Virtual Currency Enforcement Actions
This morning, the Enforcement Director of the U.S. Commodity Futures Trading Commission (“CFTC”), James McDonald, and the Enforcement Co-Directors of the U.S. Securities and Exchange Commission (“SEC”), Stephanie Avakian and Steven Peikin issued a joint statement addressing virtual currency enforcement actions (collectively “the Agencies”). In the statement, the Agencies made a commitment that “[w]hen market participants engage in fraud under the guise of offering digital instruments — whether characterized as virtual currencies, coins, tokens, or the like — the SEC and CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws.” The statement noted the Agencies’ commitment to “continue to address violations and to bring actions to stop and prevent fraud in the offer and sale of digital instruments.” This statement illustrates the federal Agencies’ shared concern that digital currencies and assets may be used as an instrument of fraud and the commitment of the Agencies to end such conduct. Joint SEC-CFTC Statement Regarding Virtual Currency Enforcement Actions
The SEC Issues Letter Taking Anti-Cryptocurrency ETF Position
This week, the SEC’s Division of Investment Management (the “Division”) issued a staff letter to the Investment Company Institute and the Securities Industry and Financial Markets Association entitled Engaging on Fund Innovation and Cryptocurrency-related Holdings. In this letter, the Division notes that the “U.S. investment fund market is one of the most robust, varied, and successful markets for investment products in the world.” The Division recognizes that part of this strength comes from “the commitment of fund sponsors to responsible innovation and continuous improvement of the products they offer.” The letter notes that the Division appreciates “that proponents of cryptocurrencies and related products have identified a range of potential benefits” and that “critics of cryptocurrencies have raised various concerns regarding the transparency of information, trading, valuation and other matters related to the nature of the underlying assets.” Accordingly, the Division notes that “at this time, [we have] significant outstanding questions concerning how funds holding substantial amounts of cryptocurrencies and related products would satisfy the requirements of the [Investment Company Act of 1940] and its rules.” The letter raises questions addressing the valuation of mutual funds and ETFs that contain cryptocurrency assets, the liquidity of such funds—which should have daily redeemability, how funds will maintain custody requirements when holding crypto assets, questions about arbitrage for ETFs, and other risks including potential manipulation. Ultimately, the letter concludes that until the questions identified within the letter can be addressed, the Division does “not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products . . . .” Source
The Treasury Department Announces Plans to Crack Down on Virtual Currency Platforms’ AML Programs
Sigal Mandelker, the U.S. Treasury Department’s under-secretary for terrorism and financial crimes, told the Senate Banking Committee this week that the U.S. Treasury is “aggressively” pursuing virtual currency platforms that lack strong internal safeguards against money laundering. Mandelker informed the Committee that Treasury’s Financial Crimes Enforcement Network will pursue malfeasant virtual currency platforms, even if they are located overseas and that the U.S. government will also encourage other countries that do not monitor anti-money laundering (“AML”) procedures to introduce stricter regulation of virtual currencies. Reuters
The CFTC Files Civil Enforcement Action in New York with Claims of Engaging in Fraudulent Virtual Currency Scheme
Thursday, the CFTC filed a federal civil enforcement action in the U.S. District Court for the Eastern District of New York against Patrick K. McDonnell and Cabbage Tech, Corp. d/b/a Coin Drop Markets (“CDM”), listing claims of fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin. CFTC Director, James McDonald, stated: “This action is among the latest examples of the CFTC’s continuing commitment to act aggressively and assertively to root out fraud and bad actors involved in virtual currencies. . . . We will continue to work hard to identify and remove bad actors from these markets.”
Specifically, the Complaint alleges that beginning in January 2017 to the present, McDonnell and CDM “engaged in a deceptive and fraudulent virtual currency scheme to induce customers to send money and virtual currencies to CDM, purportedly in exchange for real-time virtual currency trading advice and for virtual currency purchasing and trading on behalf of the customers under McDonnell’s direction.” The Complaint alleges that “Defendants never provided to such customers continuous, real-time trading signals, advice, or trading expertise through its social media chatrooms, through online communications such as via Twitter, or through its website.” The Complaint continues to allege that “Defendants stopped communicating with their customers and simply misappropriated the funds.” The Compliant requests damages in the form of: restitution to defrauded customers, disgorgement of benefits from violations of the Commodity Exchange Act and CFTC Regulations, civil monetary penalties, trading bans, and a permanent injunction against future violations of federal commodities laws. CFTC Press Release; CFTC Complaint.
The CFTC Files Civil Enforcement Action in Colorado with Claims of Engaging in a Bitcoin and Binary Options Fraud Scheme
The CFTC also filed a federal civil enforcement action in the U.S. District Court for the Eastern District of New York Thursday against Dillon Michael Dean and his company The Entrepreneurs Headquarters Limited. The Complaint charges the Defendants with engaging in a fraudulent scheme to solicit Bitcoin from the public, misrepresenting that customers’ funds would be pooled and invested in products including binary options, making Ponzi-style payments to commodity pool participants from other participants’ funds, misappropriating pool participants’ funds, and failing to register with the CFTC as a Commodity Pool Operator (“CPO”) and Associated Person of a CPO. CFTC Director of Enforcement, James McDonald, commented: “Increased public interest in Bitcoin and other virtual currencies has provided new opportunities for bad actors. . . . As this case shows, the CFTC will continue to take swift action to stop such fraudulent schemes and to hold fraudsters accountable for their misconduct.”
The Complaint alleges that from April 2017 to the present, the Defendants “engaged in a fraudulent scheme to solicit at least $1.1 million worth of Bitcoin from more than 600 members of the public to participate in a pooled investment vehicle for trading commodity interests.” The Complaint continues with allegations that instead of “convert[ing] customer funds, security, or property (“funds”) from Bitcoin to fiat currency to invest in binary options contracts, as promised, Defendants misappropriated their customers’ funds (including by using them to pay other customers, in the manner of a Ponzi scheme), and then lied to customers about their account balances” in order to conceal the alleged misappropriation. The Complaint requests damages in the form of: civil monetary damages, remedial ancillary relief, trading and registration bans, restitution, disgorgement, rescission, as well as pre- and post-judgment interest.
Press Release; Complaint
Texas Securities Commissioner Orders Crypto-Promoter to Halt Sales
Earlier this month, the Texas Securities Commissioner entered an Emergency Cease and Desist Order to stop several investment programs operated by bitcoin and crypto-community platform, Bitconnect. The state asserted that Bitconnect used sales agents to offer investments to Texas investors, promised a specific rate of return on investments, offered an investment lending program, a staking program that offered specific investment returns that could be earned through Proof of Stake minting (described as “the process in which rewards are distributed to those helping maintain the security of the network via proof of holding”), and an initial coin offering, among other offerings. The Texas Securities Commissioner took the position that the lending and staking programs were not registered or permitted to operate in Texas. The Order also asserts that the Company engaged in fraud in the offer of investments and staking programs and that the Company made materially misleading and deceptive statements in its offered program advertisements.
Announcement on Board Website; Bitconnect Cease & Desist Order.
The Ninth Circuit Weighs in on California Law Addressing Credit Card Surcharges, Cash Discounts, and the First Amendment
The U.S. Court of Appeals for the Ninth Circuit, in a panel opinion, affirmed the district court’s grant summary judgment in favor of plaintiff holding that a California law (Cal. Civ. Code § 1748.1(a)) violates the First Amendment as applied to the plaintiffs, by banning merchants from charging credit card surcharges while simultaneously allowing discounts for payments made in cash or by other means. The merchants argued that charging a surcharge to customers paying with a credit card is a more effective tool than offering a cash-payer discount in order to avoid the 2-3% charges the merchants must pay to run credit card transactions. The merchants also argued that the statute was a content-based restriction on commercial speech rather than an economic regulation. Following a complete First Amendment analysis, the panel concluded that Section 1748.1 restricted plaintiff’s non-misleading commercial speech and was not sufficiently narrowly drawn to protect the state’s interest in preventing consumer deception. The panel agreed with the district court that the statute violates the First Amendment as applied to the merchant plaintiffs. The panel limited the effect of the ruling to the merchants in the lawsuit, however the case could serve as precedence for other merchants. This ruling follows the Supreme Court’s decision in March 2017 to remand a New York surcharge case, Expressions Hair Design v. Schneiderman, for further First Amendment analysis. See Italian Colors Restaurant v. Becerra, No. 15-15873 (9th Cir. Jan. 3, 2018), opinion available at http://cdn.ca9.uscourts.gov/datastore/opinions/2018/01/03/15-15873.pdf; and additional analysis available at http://www.digitaltransactions.net/appellate-court-sides-with-merchants-challenging-californias-credit-card-surcharge-ban/.
South Korea Continues to Explore Limiting Domestic Trading of Cryptocurrency
The debate continues in South Korea on the position the country will take regarding regulation of cryptocurrencies. Earlier this month, the Ministry of Justice (“MOJ”) announced its plan to introduce a bill that would ban any cryptocurrency trading on local exchanges. But on that same day, the Presidential Office of Korea released a statement taking the position that no such consensus had been reached among government agencies and internal discussions on the issue are ongoing.
This week, the South Korean chief of the Financial Services Commission stated: “[The government] is considering both shutting down all local virtual currency exchanges or just the ones who have been violating the law.” The Bank of Korea Governor, Lee Ju-yeol, separately took the position in a recent news conference that “cryptocurrency is not a legal currency and is not being used as such as of now.” However, as demonstrated in the media, no formal decisions have yet been made. In response to public outcry against these formal positions, the Bank of Korea Governor, Lee Ju-yeol, recently stated: ”We have started looking at virtual currency from a long-term standpoint, as central banks could start issuing digital currencies in the future. This sort of research has begun at the Bank of International Settlements and we are part of that research.”
At a minimum, it appears that the country will likely impose some AML/KYC procedure requirements on cryptocurrency transactions. According to Kim & Chang, a South Korean law firm, in a January 15, 2018 statement, the South Korean government announced that it plans to start a “Real Name Policy” for cryptocurrency transactions. The law firm reports that these plans were announced as part of its special measures on December 28, 2017. According to Kim & Chang, “[u]nder the Real Name Policy, all local cryptocurrency exchanges would be able to verify the status of each account holder so that they can restrict any non-resident or minor from trading cryptocurrencies through their trading systems.” Simultaneously, the government has announced its intent “to strictly regulate any market manipulation, money laundering, tax evasion and other unlawful acts involving cryptocurrency through concerted efforts among the Prosecutors′ Office, the police and the financial regulatory authorities.” The government has also expressed its intent to support and promote research and development activities surrounding blockchain technologies. See Reuters