U.S. Developments

Telegram Submits Answer to SEC Complaint Regarding TON Blockchain Network

On November 12, Telegram Group Inc. (Telegram) submitted its answer and affirmative defenses to a complaint filed against it by the U.S. Securities and Exchange Commission (SEC) in federal court. The SEC previously filed an emergency action against Telegram and received a temporary restraining order to prohibit the launch of the Telegram Open Network (TON) blockchain and the issuance of “Grams,” the company’s virtual currency.

In its answer to the SEC complaint, Telegram argues that its offering of investment contracts known as “Simple Agreements for Future Tokens” or “SAFTs” were compliant with the federal securities laws and offered pursuant to a valid exemption from the registration requirements under the Securities Act of 1933. The company also maintains that its actions regarding the SAFTs were consistent with the guidance offered by the SEC at the time and were conducted in good faith based upon the public comments made by SEC officials at the time. Specifically, Telegram cites various SEC statements and actions on the subject.

Similar to arguments raised by Kik Interactive Inc. in its answer to the SEC in August, Telegram argues that the SEC failed to provide clear guidance regarding the sale of digital assets and securities law violations. Telegram claims that by not providing sufficient notice regarding the application of the securities laws to digital assets, they were deprived of due process rights.

Telegram’s full answer can be found here.

SEC Issues Annual Report for Fiscal Year 2019, Includes Details on ICO Settlements

On November 6, the SEC Division of Enforcement issued its annual report for fiscal year 2019 describing its accomplishments for the year. Overall, the SEC obtained judgments and orders totaling more than $4.3 billion in disgorgement and penalties.

Notably, the annual report discussed three settlements with initial coin offering (ICO) issuers for registration violations under the Securities Act of 1933. In regard to the settlements, each issuer agreed to similar undertakings. Specifically, each was required to offer refunds to investors and register their tokens with the SEC. The SEC also noted that two of the three settlements included a civil penalty (Airfox and Paragon Coin) while a third did not (Gladius). Gladius was not assessed a civil penalty due to its actions to remediate its violations with the SEC. The report contends that these settlements could provide a blueprint for future settlements with ICO issuers. The SEC also noted that the settlements provide a path to compliance for issuers while also giving potentially harmed investors an opportunity to seek rescission.

Shortly following the release of the report, the Wall Street Journal reported that several of the companies referenced in the report may be finding it difficult to meet the various deadlines within the settlements. The article stated that, of the three settlements referenced in the report, “two of the companies missed their original deadline” and a third “is more than five months behind its target date for giving investors information needed to judge whether to seek a refund.”

The full text of the report can be found here. The Wall Street Journal article can be found here.

Federal Reserve Releases its Financial Stability Report for November 2019

The Federal Reserve released its current assessment of the U.S. financial system’s resilience. The report is intended to “promote public understanding and increase transparency and accountability for the Federal Reserve’s views on the topic.”

The report focuses on “monitoring vulnerabilities” and does so by emphasizing four categories of analysis: (1) valuation pressures, (2) borrowing levels of businesses and households, (3) leverage within the financial sector, and (4) specific funding risks.

The Financial Stability Report for November 2019 can be found here.

Director of FBI, Christopher Wray: Virtual Currencies Are a “Significant Issue”

FBI Director Christopher Wray discussed cryptocurrencies in the context of U.S. National Security in his testimony before the Senate’s Homeland Security and Governmental Affairs Committee.

During the hearing, Senator Mitt Romney posed a question to Director Wray regarding the nature of cryptocurrency and its impact on terrorism financing. After noting that cryptocurrency appeared to be a tool to hide money, thereby making the work of the FBI more difficult, the Senator asked Director Wray “if there should be some kind of effort taken in our nation to deal with cryptocurrency and the challenges that [it] presents for law enforcement and deterrence of terrorist activity.”

In response to the question, Director Wray mentioned that the FBI is looking, from an investigative perspective, into the challenges both cryptocurrency and default encryption pose to law enforcement. Director Wray then mentioned that it would be harder for him to speak to whether the proper response would be subjecting cryptocurrency to some form of regulation. Director Wray went on to state, in regard to the direction that the United States, and the world, is moving, “if we don’t get our act together, money, people, communications, evidence, facts—all of the bread and butter for all of us to do our work—will be essentially walled off from the men and women we represent.”

Director Wray’s comments were not limited to virtual currencies; the Director also mentioned how default encryption within messaging applications is increasing strain on the traditional tools of law enforcement.

The Director’s full testimony can be found here.

FBI Arrests Two “SIM Swappers” After Thefts of Virtual Currencies

Two individuals in Massachusetts were arrested and charged with stealing social media accounts and virtual currencies, leveraging a technique referred to as “SIM swapping.”

SIM swapping occurs when an attacker contacts the phone service provider of a victim and convinces the service provider to port a victim’s phone number to a new SIM card. Once the attacker gains access to the phone number of the victim, he or she then uses the victim’s phone number to access accounts linked to the victim’s phone, such as social media or virtual currency exchange accounts.

The two individuals specifically targeted executives of companies involved in virtual currencies and others that have large social media followings in the virtual currency space. The individuals were charged with conspiracy, wire fraud, computer fraud and identity theft. The FBI and IRS Criminal Investigations are investigating the case.

The Justice Department’s press release on the charges can be found here.

FTC Commissioner Supports the Development of the FedNow Real-Time Payment System

On November 7, 2019, Federal Trade Commission (FTC) Commissioner Rohit Chopra wrote a letter to the FRB supporting the FRB’s FedNow Service real-time payments system. In his letter, he notes that the FedNow Service is “a natural extension of the Federal Reserve’s existing role” in the payment system to be a public competitor to The Clearing House’s Real-Time Payment System, and to “prevent a megabank monopoly over a core function of our financial system.”  His letter goes on to focus on the benefits of real-time payments to consumers, particularly low-income consumers and small businesses, stressing how such control and speed of payments could help avoid delays and associated fees. Chopra notes that without a public competitor, the “fate of faster payments is uncertain.”  He is especially concerned because he believes the private sector has also only shown “lagging efforts to meet the demand for immediate funds transfers.”  As a result, he notes that companies will endeavor to meet the demand for real-time payments, but the benefits will not flow to those that need it most and would be served by a public option.

Canadian Firm Receives DHS Grant to Track Cross-Border Oil Transfers Using Blockchain

The Department of Homeland Security (DHS) Science and Technology Directorate (S&T) awarded a $182,700 grant to Mavennet, a Canadian blockchain company, as part of its Silicon Valley Innovation Program (SVIP).

Mavennet built a blockchain-based platform that enables “real-time auditability of the natural gas trading markets in Canada.” As part of the grant, Mavennet will adapt this technology to enable government agencies, such as Customs and Border Protection, to track cross-border oil imports more effectively.

“Mavennet’s platform could provide this digital auditability while ensuring broad interoperability by supporting emerging World Wide Web Consortium standards such as decentralized identifiers and verifiable credentials,” said Anil John, S&T’s SVIP Technical Director.

The DHS press release on the grant can be found here.

International Developments

Bank for International Settlements (BIS) Establishes Singapore Innovation Hub, Appoints Outgoing European Central Bank (ECB) Executive Board Member as Head of Program

In an op-ed published on November 13, Agustín Carstens announced the opening of a Singapore Innovation Hub as the final office of the BIS Innovation Hub program.

In the op-ed, Mr. Carstens described the Singapore Hub as a location that will focus on the development of a “foundational public digital infrastructure,” which he described as a “global stack” that would bring accounts and financial services onto a single platform. The goal of this new infrastructure would be to increase the accessibility of financial services and enable faster and cheaper payments.

BIS operates two other Innovation Hubs, in Hong Kong and Switzerland. The Switzerland Hub’s focus is to examine the benefits of tokenization, while the Hong Kong Hub’s purpose is to explore blockchain’s impact on trade finance.

This effort is a part of BIS’s broader mission to strengthen central banks as a response to the goals of “Big Tech” stablecoins. The op-ed comes just after an announcement that Benoît Cœuré, a member of the European Central Bank’s Executive Board, will be heading up BIS’s Innovation Hub.

The press release announcing the appointment of Benoît Cœuré as head of the BIS Innovation Hub can be found here. The full op-ed can be found here.

German Financial Authority Issues Cease and Desist Order to Karatbit, an Alleged Pyramid Scheme

On November 11, the German Federal Financial Supervisory Authority (BaFin), announced that it issued a cease and desist order to the Karatbit Foundation to wind up its electronic money business within Germany.

In the Order, BaFin stated that Karatbit had issued the “KaratGoldCoin” without the required license. The Company used former soccer stars from Germany to promote its products. In a video taken at an event to promote KaratGoldCoin, one promoter was recorded telling the crowd, “[t]he most important thing is you have to believe.”

This order comes after authorities in several other countries, including the United States, issued orders against the company or warned investors about the company.

The BaFin cease and desist order can be found here.

Iran Announces Fees on Virtual Currency Mining

The government of Iran has announced that it will levy fees on individuals using the national power grid to mine virtual currencies. The government had previously banned the use of government subsidized electricity for virtual currency mining activity during peak hours, which can span 300 hours a year.

The program also rewards individuals for exposing virtual currency miners who operate in violation of the ban. The reward for reporting an illicit virtual currency miner to the government is a fee of 20% of the recovery of damages caused to the national power grid.

An article from The Block reporting on the tariff can be found here.

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Photo of Donald Mills Donald Mills

DJ Mills is an associate within the firm’s Financial Services practice group and centers his practice on emerging and established fintech companies, with an emphasis on the digital asset custody space. He assists clients with a broad range of regulatory and transactional matters…

DJ Mills is an associate within the firm’s Financial Services practice group and centers his practice on emerging and established fintech companies, with an emphasis on the digital asset custody space. He assists clients with a broad range of regulatory and transactional matters, including those that implicate money services, securities, and banking law.