- CFTC and DOJ Actions Involving BitMEX
- SEC Settlement with Salt Lending
- CFTC Action Against PaxForex
- Summary Judgment Granted in SEC Action Against Kik
- FinCEN and OFAC Issue Advisories on Ransomware
- FinCEN Director Blanco Speech at ACAMS AML Conference
- French Authorities Investigate Use of Virtual Currency to Fund Terrorism
CFTC and DOJ Actions Involving BitMEX
On October 1, 2020, the U.S. Commodity Futures Trading Commission (CFTC) and the U.S. Department of Justice (DOJ) announced parallel civil and criminal legal actions involving the offshore digital asset derivatives trading platform BitMEX.
The CFTC Civil Action
The CFTC filed a complaint against an assortment of offshore holding and operating companies associated with the BitMEX trading platform, including the Seychelles-based HDR Global Trading Limited that owns and operates the trading platform (collectively, BitMEX), as well as BitMEX’s co-founders, Arthur Hayes, Ben Peter Delo, and Samuel Reed. The complaint alleges that BitMEX and its co-founders illegally offered futures, swaps, options, and retail commodity transactions to retail U.S. customers without registering with the CFTC as an exchange or future commission merchant (FCM). Additionally, the CFTC alleges that BitMEX was required to comply with CFTC regulations applicable to FCMs despite it not being registered as such and violated CFTC Rule 166.3, which requires FCMs to diligently supervise their officers, employees, and agents, and CFTC Rule 42.2, which requires FCMs to comply with Bank Secrecy Act anti-money laundering requirements.
The complaint alleges that the unregistered BitMEX derivatives trading platform “conducted trillions of dollars in digital asset derivatives transactions and earned fees worth more than $1 billion from transactions on its platform.” The CFTC maintains that BitMEX offered two types of financially-settled futures contacts: a financially-settled swap product and up to 100-to-1 leveraged financially-settled digital asset transactions. Because all of these transactions were allegedly financially-settled or, in other words, did not provide for delivery of the underlying digital asset but instead settled with payment in bitcoin or cash, none of these satisfied the “actual delivery” standard per the CFTC’s recent final interpretative guidance on retail virtual currency transactions (see our client alert on the guidance here). BitMEX operated a proprietary trading desk that would act as counterparty to transactions on its platform and assume customer positions under certain circumstances. Additionally, BitMEX allegedly did not perform any know-your-customer diligence on users of the trading platform and permitted “customers to open accounts with an anonymous email and password, and a deposit of bitcoin.”
The CFTC seeks permanent injunctions prohibiting the defendants from further engaging in violations of the CEA and CFTC regulations and from participating in regulated U.S. commodity markets, disgorgement of all benefits received by the defendants, “including, but not limited to trading profits, revenues, salaries, commissions, loans, or fees derived, directly or indirectly, from [BitMEX’s violations of the CEA and CFTC regulations],” rescission of all contracts and agreements entered into between the defendants and customers and investors in violation of the CEA and CFTC regulations, restitution to all customers and investors whose funds were received or utilized in violations of the CEA and CFTC regulations, and an assessment of civil monetary penalties.
The DOJ Criminal Indictment
The U.S. Attorney for the Southern District of New York and the Federal Bureau of Investigation announced the criminal indictment of BitMEX co-founders Arthur Hayes, Benjamin Delo, Samuel Reed, and Gregory Dwyer for violations of the Bank Secrecy Act. Specifically, the indictment charges the co-founders with “violating the Bank Secrecy Act and conspiring to violate the Bank Secrecy Act, by willfully failing to establish, implement, and maintain an adequate anti-money laundering (AML) program.”
Law enforcement arrested Samuel Reed in Massachusetts on Thursday, but the other three founders remain at large.
SEC Settlement with Salt Lending
On September 30, 2020, the U.S. Securities and Exchange Commission (SEC) settled charges against Salt Blockchain Inc., f/k/a Salt Lending Holdings, Inc. (Salt) in connection with its 2017 public sale of Salt Tokens. The order states—with Salt not admitting or denying the allegations—that Salt Tokens constituted “securities” under the federal security laws because “Salt purchasers had a reasonable expectation of obtaining a future profit from Salt’s efforts” and therefore Salt conducted an illegal unregistered offering of securities. Among other things, the order requires Salt to pay a civil monetary penalty of $250,000, refund investors that submit claims to Salt the purchase price of their purchases of Salt Tokens together with interest, and file a Form 10 to register the Salt Tokens as a class of securities with the SEC.
CFTC Action Against PaxForex
On September 28, 2020, the CFTC announced the filing of a complaint against Laino Group Limited d/b/a PaxForex (PaxForex), a foreign trading platform that offered digital assets to retail customers on a leveraged, margined or financed basis.
PaxForex operated a trading platform that solicited and accepted orders from U.S. customers for transactions in “contracts for difference” (CFD) referenced to the prices of commodities, including digital assets. A CFD is an agreement to exchange the difference in value of an underlying commodity between the time at which the position is established and the time at which it is terminated.
The CFTC alleges that PaxForex is not a CFTC-registered exchange and illegally offered leveraged transactions to U.S. customers who did not qualify as eligible contract participants that did not settle with “actual delivery” within 28 days. Moreover, the CFTC alleges that PaxForex was required to register as an FCM in order to offer leverage, margin or financing in connection with retail commodity transactions.
Summary Judgment Granted in SEC Action Against Kik
Judge Alvin Hellerstein granted summary judgment to the SEC in its lawsuit against Kik Interactive Inc. (Kik), determining that Kik conducted an illegal unregistered offering of securities when it sold Kik Tokens to the public in its $100 initial coin offering. Judge Hellerstein’s opinion states:
I hold that undisputed facts show Kik offered and sold securities without a registration statement or exemption from registration, in violation of Section 5. Therefore, the SEC’s motion for summary judgment is granted, and Kik’s motion for summary judgment is denied.
The court’s granting of summary judgment means that, in the court’s opinion, there is no genuine dispute as to any material fact and the SEC is entitled to judgment as a matter of law under the facts. The opinion states that purchasers of Kik Tokens had a reasonable expectation of profits derived from the entrepreneurial or managerial efforts of others and therefore the offering of Kik Tokens constituted a securities offering. Moreover, the court held that Kik’s pre-sale of Kik Tokens was part of an integrated offering with the public token sale.
FinCEN and OFAC Issue Advisories on Ransomware
On October 1, 2020, the U.S. Financial Crimes Enforcement Network (FinCEN) and the U.S. Office of Foreign Assets Control (OFAC) issued advisories regarding ransomware. Both of these advisories explain that ransomware schemes typically involve convertible virtual currency (CVC) as it is the “preferred payment method of ransomware perpetrators.” The FinCEN advisory reminds money services businesses of their obligations to monitor for red flags and file suspicious activity reports in connection with incidents of ransomware “conducted by, at, or through the financial institution,” including with respect to ransom payments made by financial institutions that are victims of ransomware. The OFAC advisory “encourages victims and those involved with addressing ransomware attacks to contact OFAC immediately if they believe a request for a ransomware payment may involve a sanctions nexus.”
FinCEN Director Blanco Speech at ACAMS AML Conference
FinCEN Director Kenneth Blanco delivered remarks to the ACAMS AML Conference on September 29, 2020, on various topics, including virtual currency.
Director Blanco focused on “crypto risk exposure.” He indicated that virtual currency exchanges and platforms are not the only businesses that need to be thinking about this. From the speech:
One issue that continues to come up . . . relates to mitigating risks associated with emerging payment systems, including virtual currency. To be clear, exchanges are not the only ones with crypto risk exposure. These risks are not unique to money services businesses or virtual currency exchangers; banks must be thinking about their crypto exposure as well. These are areas your examiners, and FinCEN, will ask you about when assessing the effectiveness of your AML program.
So banks also need to be asking themselves, “What baseline controls do we have in place to identify customers? Do we have institutional or peer-to-peer virtual currency customers? How does our financial institution interact with emerging payment systems? Do we have the tools we need to identify and report potentially suspicious activity occurring through our financial institution?” All of these questions go back to the policies and procedures in place to mitigate risk.
If banks are not thinking about these issues, it will be apparent when examiners visit.
French Authorities Investigate Use of Virtual Currency to Fund Terrorism
On September 29, 2020, French police arrested 29 people in connection with a financing network that utilized virtual currency to finance Islamic extremists in Syria affiliated with al-Qaida.
ABC News reports that the financing network has been active since 2019 and involved an elaborate scheme involving “cryptocurrency coupons.” From ABC News:
It was based mainly on the purchase in France of cryptocurrency coupons whose details were transferred by secure messaging to jihadis in Syria, who could then retrieve the money through cryptocurrency platforms.
The prosecutor’s office said that dozens of people in France constantly and anonymously bought cryptocurrency coupons worth 10 to 150 euros ($11 to $165). The coupons were credited to accounts opened abroad by jihadis who then converted them into cryptocurrency. Cryptocurrencies can be sold for cash on online exchanges.
Hundreds of thousands of euros are thought to have been supplied via the network, benefiting members of al-Qaida still hiding out in northwest Syria, but also jihadis of the Islamic State group, which has been on the run since its leader Abu Bakr al-Baghdadi, died during a raid by U.S. forces in October 2019.