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District Court concludes a small virtual currency is a “commodity” under the Commodities Exchange Act
On September 26, the U.S. District Court for the District of Massachusetts denied a virtual currency trading company’s motion to dismiss, concluding that smaller virtual currencies are commodities that may be regulated by the CFTC. In January, the CFTC bought an action alleging the company violated the Commodities Exchange Act (CEA) and CFTC Regulation 180.1(a) by making false or misleading statements and omitting material facts when offering the sale of their company’s virtual currency. For example, the complaint alleges that the company falsely stated that its virtual currency was backed by gold, could be used anywhere Mastercard was accepted, and was being actively traded on several currency exchanges. Moreover, while consumers who purchased the virtual currency could view their accounts, they were unable to trade it or withdraw funds from their accounts with the company. The company moved to dismiss the case, arguing that the conduct did not involve a “commodity,” specifically one that underlies a futures contract, under the CEA. In denying the motion to dismiss, the court determined that Congress intended for the CEA to cover a certain “class” of items and specific items within that class are then “dealt in.” Because the company offered a type of “virtual currency” and it is “undisputed that there is futures trading in virtual currencies (specifically involving Bitcoin),” the court held that the CFTC sufficiently alleged the company’s product is a “commodity” under the CEA. The court also rejected the company’s other arguments, determining Regulation 180.1(a) was meant to combat the fraud alleged by the CFTC, notwithstanding its use of the term “market manipulation,” and the CFTC adequately pleaded the fraudulent claim under the regulation.
On September 4, the OCC, Federal Reserve Board, FDIC, SEC, and CFTC (the Agencies) announced a 30-day extension to the public comment period for the Agencies’ joint revisions to the Volcker Rule. The comment period, which was previously scheduled to end on September 17, is now extended until October 17. The joint release notes that the extension will give interested parties “approximately four and a half months from the date the proposal was released to the public to submit comments,” as the Agencies’ first released the text of the proposal on May 30 (it was not published in the Federal Register until July 17). As previously covered by InfoBytes, the Agencies’ joint revisions are designed to simplify and tailor obligations for compliance with Section 13 of the Bank Holding Company Act, known as the Volcker Rule, which restricts a bank’s ability to engage in proprietary trading and own certain funds. Specifically, according to a Federal Reserve Board memo, the proposed amendments will better align Volcker rule requirements with a bank’s level of trading activity and risks.
On August 23, the U.S. District Court for the Eastern District of New York entered final judgment in favor of the Commodity Futures Trading Commission (CFTC) in its suit against a cryptocurrency trading advice company and its owner (defendants) for allegedly misappropriating investor money through a cryptocurrency trading scam. As previously covered by InfoBytes in March, the court granted the CFTC’s request for a preliminary injunction, holding that the CFTC has the authority to regulate virtual currency as a “commodity” within the meaning of the Commodity Exchange Act and that the CFTC has jurisdiction to pursue fraudulent activities involving virtual currency even if the fraud does not directly involve the sale of futures or derivative contracts. The final judgment orders the defendants to pay over $1.1 million in restitution and civil money penalties and permanently enjoins them from engaging in future activities related to commodity interests and virtual currencies.
On August 9, Financial Crimes Enforcement Network (FinCEN) Director Kenneth A. Blanco delivered remarks at the 2018 Chicago-Kent Block (Legal) Tech Conference to discuss, among other things, the agency’s approach to virtual currency and its efforts to protect financial institutions from being exploited for illicit financing purposes as new financial technologies evolve and are adopted. Blanco commented that while innovation provides customers with greater access to financial services, it can also create opportunities for criminals or serve as a vehicle for fraud. Blanco discussed several areas of focus, such as (i) the regulation of virtual currency and initial coin offerings (ICOs), along with coordinated policy development and regulatory approaches done in conjunction with the SEC and CFTC; (ii) examination and supervision efforts designed to “proactively mitigate potential illicit finance risks associated with virtual currency”; (iii) anti-money laundering/countering the financing of terrorism (AML/CFT) regulatory compliance expectations for companies involved in ICOs or virtual currency transmissions; (iv) enforcement actions taken against companies that fail to implement effective programs; (v) the rise and importance of virtual currency suspicious activity report filings which help the agency identify and investigate illicit activity; and (vi) the development of an information sharing virtual currency-focused FinCEN Exchange program. Blanco emphasized that “individuals and entities engaged in the business of accepting and transmitting physical currency or convertible virtual currency from one person to another or to another location are money transmitters subject to the requirements” of the Bank Secrecy Act.
On August 2, the Commodity Futures Trading Commission (CFTC) announced multiple whistleblower awards, totaling $45 million, to individuals who volunteered information that led to successful enforcement actions. Earlier in July, the CFTC also announced its largest award, of approximately $30 million, to one whistleblower (previously covered by InfoBytes here), and the first award made to a whistleblower living in a foreign country. Under the CFTC’s whistleblower program, eligible whistleblowers can receive between 10 and 30 percent of the monetary sanctions collected from the resulting enforcement action. The CFTC’s Enforcement Director anticipates that this trend of substantial awards will “continue as the Commission continues to receive increasing numbers of high-quality whistleblower tips.”
On July 16, the CFTC issued an advisory to alert customers to exercise caution and conduct thorough research prior to purchasing virtual/digital coins or tokens. Specifically, customers are reminded (i) to conduct extensive due diligence on all “individuals and entities listed as affiliates of a digital coin or token offering”; (ii) to confirm whether the digital coins or tokens are securities and, if so, verify that the offering is registered with the SEC before investing in an Initial Coin Offering (ICO); (iii) to verify how the money will be utilized, if they can get it back, and what rights the digital coin or token provides; and (iv) that many ICOs are frauds.
On July 17, the OCC, Federal Reserve Board, FDIC, SEC, and CFTC (the Agencies) published their joint notice of proposed rulemaking designed to simplify and tailor compliance with Section 13 of the Bank Holding Company Act’s restrictions on a bank’s ability to engage in proprietary trading and own certain funds (the Volcker rule). As previously covered in InfoBytes, the Agencies’ announced the proposal on May 30, noting that the amendments would reduce compliance costs for banks and tailor Volcker rule requirements to better align with a bank’s size and level of trading activity and risks. Comments on the proposal are due by September 17.
On July 12, the Commodity Futures Trading Commission (CFTC) announced an approximately $30 million award to a whistleblower who volunteered information that led to an enforcement action. This is the fifth and largest award—previously the highest was around $10 million— given by the CFTC’s whistleblower program, created by the Dodd-Frank Act. Director of the CFTC’s Whistleblower Office, Christopher Ehrman, stated, “The award today is a demonstration of the program’s commitment to reward those who provide quality information to the CFTC.” Under the CFTC’s program, whistleblowers are eligible to receive between 10 and 30 percent of the monetary sanctions collected from the resulting enforcement action.
The announcement does not provide details of the information provided or the related enforcement action.
FDIC FIL addendum: Federal banking agencies will not enforce Volcker rule for financial institutions exempt under S.2155
On June 4, the FDIC issued FIL-31-2018, which contains an addendum describing legislative changes to Section 13 of the Bank Holding Company Act (Volcker rule) under the Economic Growth, Regulatory Relief, and Consumer Protection Act (S.2155/P.L. 115-174) that are applicable to FDIC-insured depository institutions with total assets under $10 billion. (See previous InfoBytes coverage on S.2155 here.) Effective immediately, any financial institution that “‘does not have and is not controlled by a company that has (i) more than $10,000,000,000 in total consolidated assets; and (ii) total trading assets and trading liabilities as reported on the most recent applicable regulatory filing filed by the institution, that are more than 5 percent of total consolidated assets’” is exempt from the rule. As result, the federal banking agencies will no longer enforce the Volcker rule for qualifying financial institutions in a manner inconsistent with the statutory amendments to the Volcker rule, and announced plans “to address these statutory amendments outside of the current notice of proposed rulemaking.”
The federal banking agencies responsible for developing the proposal (the Federal Reserve Board, CFTC, FDIC, OCC, and SEC) also formally announced on June 5 a joint notice and request for public comment on the proposed revisions. Comments will be accepted for 60 days following publication in the Federal Register.
Visit here for InfoBytes coverage on the federal banking agencies’ proposed revisions to the Volcker rule announced May 30.
On May 30, the Federal Reserve Board (Board) announced proposed revisions designed to simplify and tailor compliance with Section 13 of the Bank Holding Company Act’s restrictions on a bank’s ability to engage in proprietary trading and own certain funds (the Volcker rule). The proposal, subject to public comment for 60 days after publication in the Federal Register, was developed in coordination with the OCC, FDIC, SEC, and CFTC, and would modify regulations finalized in December 2013 to reduce compliance costs for banks. Two information collections were issued along with the proposal: Information Schedules and Quantitative Measurements Daily Schedule.
According to a Board memo, the proposed amendments would tailor Volcker rule requirements to better align with a bank’s level of trading activity and risks. The proposal would establish the following three categories based on trading activity: (i) “significant trading assets and liabilities,” which would consist of banks with gross trading assets and liabilities of at least $10 billion, and require a comprehensive compliance program tailored to reflect the Volcker rule’s requirements; (ii) “moderate trading assets and liabilities,” which would include banks with gross trading assets and liabilities of at least $1 billion but less than $10 billion, and impose reduced compliance obligations; and (iii) “limited trading assets and liabilities,” which would include banks with less than $1 billion in gross trading assets and liabilities, and subject them to the lowest level of regulatory compliance.
In addition, the proposal would, among other changes:
- provide more clarity by revising the definition of “trading account” to be an account used to buy or sell financial instruments recorded at fair value under commonly used accounting definitions;
- clarify that banks whose trades do not exceed appropriately developed internal risk limits are engaged in permissible market-making-related activity;
- streamline the criteria that applies when a bank relies on the hedging exemption from the proprietary trading prohibition, and remove a requirement that a trade “demonstrably reduces or otherwise significantly mitigates” a specific risk;
- ease the documentation requirement banks face when demonstrating trades are hedges, and eliminate requirements that a bank with only moderate or limited trading activity must develop “a separate internal compliance program for risk-mitigation hedging”;
- eliminate the 60-day rebuttable presumption for trades;
- expand the scope of the “liquidity management exclusion” in the Volcker rule to allow banks to use foreign exchange forwards, foreign exchange swaps, and physically settled cross-currency swaps as a part of liquidity management activities;
- limit the impact of the Volcker rule on foreign banks’ activity outside of the U.S.; and
- simplify the type of trading activity information that banks will be required to provide to the agencies.
Federal Reserve Board Chair Jerome Powell noted that after nearly five years of experience applying the Volcker rule, the proposed rule is a way to “allow firms to conduct appropriate activities without undue burden, and without sacrificing safety and soundness.”
Federal Reserve Board Governor Lael Brainard also commented that “[r]ather than requiring banking institutions to undertake specific quantitative analyses prescribed by the regulators, the proposed revisions would require banking institutions to establish internal risk limits to achieve the principle of not exceeding the reasonably expected near-term demands of customers, subject to supervisory review.”
Federal Reserve Board Vice Chair of Supervision Randal Quarles stated that while the regulatory relief bill signed into law on May 24 exempts banks with less than $10 billion in total assets from the Volcker rule (see previous InfoBytes coverage here), the “proposed rule, however, would recognize that small asset size is not the only indicator of reduced proprietary trading risk.” Furthermore, the proposed rule is a “best first effort at simplifying and tailoring the Volcker rule” and does not represent the “completion of [the Board’s] work.”