U.S. Regulatory Developments
Bill Addressing Tax Treatment of Crypto Transactions Introduced to the House
On January 16, 2020, Congresswoman Suzan DelBene (WA) and Congressman David Schweikert (AZ) introduced the “Virtual Currency Tax Fairness Act” (H.R. 5635). This bill would amend the Internal Revenue Code of 1986 to address some transactions made with virtual currency. Drafters of the bill intend to create a “structure for taxing purchases made with virtual currency, further strengthening the legitimacy of virtual currency in the digital economy by creating parity in the tax code.”
Presently, when a person uses virtual currency in a transaction, any gain resulting from exchange rates must be reported as taxable income—regardless of the size or purpose of the transaction. This bill would provide a de minimis exemption for personal transactions made with virtual currency when the gains are less than or equal to $200.
Please click here to read Representative Schweikert’s Press Release.
Please click here to read Representative DelBene’s Press Release.
Oklahoma Lawmaker Proposes a State-Chartered Crypto Financial Institution
Oklahoma Senate Bill 1430 was introduced this week. This bill relates to implementing blockchain technologies and will direct the planning of a new state-chartered financial institution for digital assets. If approved, the financial institution would serve as “the central depository for virtual currency used by governmental agencies in th[e] state.” The measure aims to provide a level of state-backed infrastructure for work relating to cryptocurrencies and blockchain. The text of the bill expresses a commitment to technology in Oklahoma stating, “Oklahoma is committing to partner with innovative technology, help develop next generation financial products, and safely grow unique technical and financial sectors in this state.”
Please click here to read the text of the SB1430.
SEC Issues Investor Alert Regarding Initial Exchange Offerings
The Securities and Exchange Commission’s (“SEC”) Office of Investor Education and Advocacy issued an investor alert this week urging investors to exercise caution before investing in “initial exchange offerings” (“IEO”) through online trading platforms. The SEC describes IEOs as a recent development in the “rapidly evolving digital asset space” that are designed to raise capital. IEOs are offered directly by online trading platforms and provide immediate trading opportunities for the digital assets sold, and are “touted” as an innovation in ICOs. The SEC also advises that these “exchanges” are not registered with the SEC as broker-dealers or alternative trading systems, and that many of these IEOs may be selling digital assets that are unregistered securities. The SEC also states that “[n]oncompliance with the federal securities laws means the IEO and/or trading platform may be operating unlawfully and the investor and market protections these laws are intended to provide may be absent.” The SEC indicates that its reach may extend to foreign exchanges, but that recovery for civil damages from a foreign defendant may be unlikely.
The alert concludes by providing “red flags” indicative of whether an IEO is operating unlawfully and by listing additional resources.
Please click here to read the full investor alert.
SEC Charges Defendants Accused of Using Fake Identities to Orchestrate a Fraudulent ICO
The SEC charged Boaz Manor, his business associate, and two businesses (CG Blockchain Inc. and BTC Inc. SEZC) this week, alleging the defendants raised over $30 million from hundreds of investors in a fraudulent ICO. According to the complaint, in 2017 and 2018, the defendants marketed and sold digital asset securities to develop technologies for hedge funds and other investors in digital assets. The complaint alleges that Manor used aliases, darkened his hair, and grew a beard to hide his identity and conceal the fact that he had served time in prison after pleading guilty to criminal charges related to the collapse of a large Canadian hedge fund. The complaint alleges that the defendants touted they had 20 hedge funds testing their technology to record transactions on a distributed ledger. According to the complaint, however, the defendants had only sent a prototype to a dozen funds and, ultimately, none of those funds used it or paid for the technology. The complaint charges Manor and his associate, Edith Pardo, with “violating the antifraud and securities registration provisions of the federal securities laws and seeks disgorgement of ill-gotten gains plus interest, penalties, and injunctive relief.” The complaint also requests orders barring Manor and Pardo from acting as officers or directors of public companies and from participating in future securities offerings.
Please click here for the SEC Press Release.
Please click here for the Complaint.
Telegram Files Memorandum Supporting its Motion for Summary Judgment Against SEC
On January 15, Telegram Group Inc. and TON Issuer Inc. (together, “Telegram”) filed papers in support of their motion for summary judgment and in opposition to the U.S. Securities and Exchange Commission (“SEC”) application for a preliminary injunction in federal court in New York. On the same day, the SEC also made a submission in support of its motion for summary judgment. These filings are the latest developments related to Telegram’s ongoing battle with the SEC relating to Telegram’s Gram cryptocurrency. Arguments presented in the briefs are summarized below.
In its brief, Telegram contends that the Grams would not be securities following the launch of the TON blockchain. Telegram argues that Gram purchasers would not have an expectation of profits based on the managerial efforts of Telegram because, among other things, (1) the Grams were designed and promoted for consumptive use; (2) Gram purchasers would not expect profits based on Telegram’s efforts; and (3) there was no “common enterprise” between Gram recipients and Telegram as such terms are defined in relevant jurisprudential tests. Telegram also contends that the initial sale of private placements related to the Grams would not constitute past violations of the securities laws because the private placements were conducted pursuant to relevant exemptions to the securities laws. Finally, Telegram argues that the SEC has failed to provide enough clarity, guidance and fair notice regarding its claims, such that Telegram could have reasonably understood they constituted violations of the securities laws.
By contrast, the SEC argues that the purchase agreements related to the Grams would constitute unregistered offerings ineligible for exemption to the securities laws because the sales were part of an ongoing public offering of the Grams. The SEC also alleges that any analysis regarding the Grams should take place at the time the purchase agreements were entered into, and not at the time of distribution. Further, the SEC argues that, even if the Grams were evaluated at the time of distribution, they would still constitute securities under the relevant jurisprudential tests.
[NOTE: We could not find direct links to the briefs. Here are PDFs embedded.]
Cabbage Tech CEO Sentenced to 33 Months in Prison
Cabbage Tech CEO, Patrick McDonnell, was sentenced to 33 months’ imprisonment for wire fraud and a scheme to defraud investors in virtual currency. McDonnell was also ordered to pay restitution in the amount of $224,352. McDonnell pled guilty in June 2019.
McDonnell had been charged with using social media to portray himself as an expert trader of virtual currency from 2014 through 2018. According to prosecutors, he promised investors he would provide trading advice and purchase and trade virtual currency on their behalf, either individually or through his company, Cabbage Tech. According to the charges, while neither McDonnell nor Cabbage Tech provided investment services, McDonnell sent investors false financial statements stating that their investments had been profitable. In total, McDonnell reportedly defrauded at least ten victims of at least $194,000 in U.S. currency, 4.41 Bitcoin, 206 Litecoin, 620 Ethereum Classic, and 1,342,634 Verge currency, for a total loss of $224,350.32.
Please click here to read the announcement from the U.S. Attorney’s Office in the Eastern District of New York.
Please click here for previous entries related to this defendant.
NBA Team Launches Live Blockchain-Powered Auction Platform
This week, the NBA’s Sacramento Kings launched the league’s first blockchain-based auction platform to sell authentic memorabilia to the public. The platform will use blockchain technology to auction items that are authenticated to each purchaser. This platform will provide a transparent provenance and transaction history, and fans “will be assured that each piece of gear is authentic.” During home games, Kings fans will be able to participate in live auctions of gear worn in the game by players.
Please click here to read the team’s press release announcing the platform.
U.N. Sanctions Expert Warns: Stay Away from North Korea Cryptocurrency Conference
United Nations (“U.N.”) sanctions experts have warned people not to attend a North Korean cryptocurrency conference, scheduled to be held in February 2020. Reportedly, this conference has been identified in a confidential report to the U.N. as a likely sanctions violation. U.N. sanctions regimes generally prohibit financial transactions, travel, technical training, advice, services or assistance to specific countries or entities within those countries; attending a conference focused on technology or how cryptocurrency could be used to evade UN sanctions would be a violation. The US Attorney’s Office for the Southern District of New York recently indicted a cryptocurrency trader, Virgil Griffith, with violating U.S. sanctions by participating in a conference in North Korea in 2019.
Please click here to read the full Reuters article reporting on the U.N. Warning.
Gemini Introduces Insurance Coverage
Cryptocurrency exchange, Gemini Trust Co., introduced its own insurance company to protect offline storage of digital coins. The new inhouse insurance company, Nakamoto Ltd., will provide a total of $200 million in coverage for cryptoassets that Gemini holds on behalf of customers. The company notes that a robust insurance program may help encourage use of virtual currency to become more mainstream. This insurance will boost coverage against theft of crypto assets.
Please click here to read the full Reuters article reporting on the Gemini insurance announcement.
Please click here to find the Gemini statement in fund insurance.
Former CFTC Chair to Launch Digital Dollar Project
Former Chairman of the Commodity Futures Trading Commission (“CFTC”), J. Christopher Giancarlo, announced plans to set up a think tank that will promote the idea of digitizing the U.S. dollar. Giancarlo is creating the nonprofit Digital Dollar Foundation, which will study ways to convert the dollar into a fully electronic currency based on blockchain. This project will also encourage research and public discourse on the potential advantages of introducing a digital dollar. Giancarlo has opined that the U.S. risks losing the advantage of having the dominant global currency if it falls behind rivals, such as China, in technology. Giancarlo says, “A digital dollar would help future-proof the greenback and allow individuals and global enterprises to make payments in dollars irrespective of space and time.” China is already creating a digital yuan, and Giancarlo intends to lead the charge to digitizing the dollar. He stated: “Like with the physical infrastructure of this country, if you don’t modernize and keep up with the times, those strengths will begin to fray.”
Please click here to read the Wall Street Journal article discussing this development.
New U.K. AML and CFT Regulations for Cryptoasset Activity will be supervised by the FCA
Following the entry into force on January 10, 2020 of most of the provisions of the United Kingdom’s Money Laundering and Terrorist Financing (Amendment) Regulations 2019, the U.K.’s Financial Conduct Authority (“FCA”) is now the designated regulator responsible for supervising anti-money laundering (“AML”) and counterterrorist financing (“CFT”) measures of UK businesses engaged in certain cryptoasset activities.
The 2019 regulations implement the European Union’s fifth Anti-Money Laundering Directive (“5AMLD”) in the U.K.’s domestic law by amending the U.K.’s Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (as amended, the “MLRs”). 5AMLD was designed to strengthen the EU’s AML and CFT regimes in order to meet the Financial Action Task Force’s (“FATF”) global standards for AML and CFT. In light of 5AMLD’s grounding in global FATF standards and the pre-existing importance of the U.K. as an international financial center, the U.K. is generally expected to maintain consistent financial crime regulations once it leaves the EU as a member state.
Under the MLRs, new U.K. businesses undertaking in scope cryptoasset activity must register with the FCA before engaging in business, and existing businesses must ensure compliance with the regulations from January 10, 2020 onwards and must be registered by January 2021 (which will require a completed application to be submitted by June 2020). Existing FCA regulated entities, such as firms regulated under the Financial Services and Markets Act, e-money institutions or payment services businesses will also be required to apply for registration if they are undertaking cryptoasset activity.
A cryptoasset business registering with the FCA must demonstrate that it has policies, controls and procedures in place to effectively manage money laundering and terrorist financing risks proportionate to the size and nature of the business’s activities. Businesses’ responsibilities to comply include, but are not limited to: (1) “identify[ing] and assess[ing] the risks of money laundering and terrorist financing which their business is subject to”; (2) “hav[ing] policies, systems and controls to mitigate the risk of the business being used for the purposes of money laundering or terrorist financing”; (3) “where appropriate to the size and nature of its business, appoint[ing] an individual who is a member of the board or senior management to be responsible for compliance with the MLRs”; (4) “undertak[ing] customer due diligence when entering into a business relationship or occasional transactions”; (5) “apply[ing] more intrusive due diligence, known as enhanced due diligence, when dealing with customers who may present a higher money laundering / terrorist finance risk. This includes customers who meet the definition of a politically exposed person”; and (6) “undertak[ing] ongoing monitoring of all customers to ensure that transactions are consistent with the business’s knowledge of the customer and the customer’s business and risk profile.”
The FCA states that it will proactively supervise businesses’ compliance with the new regulations and that it will take “swift action” when businesses do not meet the desired standards and cause risks to market integrity. Potential cryptoasset businesses should be aware that registering with the FCA is not the same as a firm obtaining authorization to conduct regulated activities in the U.K., nor is it a license, recommendation or endorsement of a business. In announcing the requirements, the FCA warned that cryptoasset businesses must not mislead their customers as to their status and any protections that may apply.
Please click here to access the FCA Press Release.
Please click here to see the latest updates from FATF.