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  • District Court rejects dismissal bid, determining plaintiff sufficiently alleged ICO tokens were unregistered stock

    Courts

    On December 10, the U.S. District Court for the District of New Jersey denied a motion to dismiss a putative class action, finding the plaintiff sufficiently alleged that a company’s sale of unregistered cryptocurrency tokens were “investment contracts” under securities law. According to the opinion, the plaintiff filed the proposed class action against the company alleging it sold unregistered securities in violation of the Securities Act after purchasing $25,000 worth of tokens during the company’s initial coin offering (ICO). The company moved to dismiss the complaint, arguing that the tokens were not securities subject to the registration requirements of the Act. The court applied the three-prong “investment contract” test from SEC v. W.J. Howey Co.—“the three requirements for establishing an investment contract are: (1) an investment of money, (2) in a common enterprise, (3) with profits to come solely from the efforts of others”—and determined the token sales met the requirements. Focusing on the second and third prongs, because the company acknowledged the first was satisfied, the court concluded that the plaintiff sufficiently alleged the existence of a common enterprise by showing a “horizontal commonality” from the pooling of the contributions used to develop and maintain the company’s tasking platform. As for the third prong, the court determined the investors had an expectation of profit rather than simply a means to use the tasking platform, as demonstrated by the company’s marketing of the ICO as a “‘unique investment opportunity’ that would ‘generate better financial returns[.]’”

    Courts Securities Initial Coin Offerings Virtual Currency Fintech

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  • OFAC announces cyber-related designations, releases digital-currency addresses to identify illicit actors

    Financial Crimes

    On November 28, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) announced sanctions pursuant to Executive Order 13694 against two Iran-based individuals for allegedly helping to facilitate the exchange of ransom payments made in Bitcoin into local currency. For the first time, OFAC also identified two digital currency addresses associated with the identified financial facilitators who are designated “for having materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of” ransomware attacks that threaten the “national security, foreign policy, or economic health or financial stability of the [U.S.]” According to OFAC, the provided digital currency addresses should be used to assist in identifying transactions and funds to be blocked as well as investigating potential connections.

    Treasury Under Secretary for Terrorism and Financial Intelligence Sigal Mandelker stated, “We are publishing digital-currency addresses to identify illicit actors operating in the digital-currency space. Treasury will aggressively pursue Iran and other rogue regimes attempting to exploit digital currencies and weaknesses in cyber and [anti-money laundering/countering financing of terrorism] safeguards to further their nefarious objectives.” OFAC issued a warning that persons who engage in transactions with the identified individuals “could be subject to secondary sanctions” and that “[r]egardless of whether a transaction is denominated in a digital currency or traditional fiat currency, OFAC compliance obligations are the same.” As a result, all property and interests in property belonging to the identified individuals subject to U.S. jurisdiction “or within or transiting” the U.S. are blocked, and U.S. persons are generally prohibited from entering into transactions with them. OFAC also released new FAQs to provide guidance for financial institutions on digital currency.

    View here for additional InfoBytes coverage on Iranian sanctions.

    Financial Crimes Department of Treasury OFAC Virtual Currency Bitcoin Sanctions Iran

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  • Court holds SEC has not proven pre-ICO cryptocurrency is a “security”

    Courts

    On November 27, the U.S. District Court for the Southern District of California denied the SEC’s motion for a preliminary injunction against a cryptocurrency company, concluding the agency failed show the currency tokens were “securities” as defined under federal securities laws. According to the order, the SEC filed a complaint against the company in October alleging it falsely claimed its initial coin offering (ICO) was registered and approved by the SEC and other regulators, including using the agency’s seal in marketing materials. At the time of the filing, the SEC claimed the company had already raised more than $2.5 million in pre-ICO sales. The SEC moved for a preliminary injunction to freeze the company’s assets and prevent the company’s owner from buying or selling securities and other digital currency during the pendency of the case. Upon review, the court noted the SEC must establish the company previously violated federal securities laws and there is a reasonable likelihood that it will happen again. The SEC argued the allegedly fraudulent marketing materials used to raise money from 32 “test investors” violated federal securities laws, while the company argued the investors did not have an expectation to receive profits as they were working with the company on the exchange’s functionality and therefore, the currency tokens were not “securities.” The court denied the SEC’s motion, concluding that it could not determine whether the tokens were “securities” under federal law without full discovery as there were disputed issues of material facts, including what the test investors relied on in terms of marketing materials before they purchased the cryptocurrency tokens.

    Courts Cryptocurrency Virtual Currency Initial Coin Offerings SEC Preliminary Injunction

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  • SEC announces first settlement with a digital currency exchange

    Securities

    On November 8, the SEC announced its first enforcement action settlement with a digital currency platform for allegedly operating as an unregistered national securities exchange. According to the cease-and-desist order, the founder of the digital currency exchange, who has since sold the exchange to foreign buyers, allegedly violated federal securities laws by providing an online platform for secondary market trading of digital assets, including ERC20 tokens, without registering with the Commission or operating pursuant to a registration exemption. ERC20 tokens are digital assets issued and distributed on the Ethereum Blockchain using the ERC20 protocol, which, according to the SEC, is the standard coding protocol currently used by a significant majority of issuers in initial coin offerings. The order emphasizes that 92 percent of the trades on the exchange took place after the SEC released its Report of Investigation Pursuant To Section 21(a) Of The Securities Exchange Act of 1934: The DAO (the DAO Report) in July 2017, advising that non-exempt digital currency exchanges must register with the Commission. Without admitting or denying the findings, the founder agreed to pay $300,000 in disgorgement plus interest and a $75,000 penalty.

    Securities Cryptocurrency Virtual Currency SEC Settlement Fintech

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  • NYDFS adds check cashing and virtual currency businesses to nationwide licensing system

    State Issues

    On October 1, NYDFS announced the commencement of the final phase of its initiative to manage the license application and regulation of all non-depository financial institutions operating in the state through the Nationwide Multistate Licensing System and Registry (NMLS). As such, NYDFS now allows financial services companies holding check casher and virtual currency business activity licenses to transition those licenses to NMLS. Additionally, companies applying for new licenses may now submit applications through NMLS. As previously covered in InfoBytes, licensed budget planners, sales finance agencies, money transmitter licensees, and mortgage providers have already made the transition to NMLS. 

    State Issues NYDFS NMLS Licensing Virtual Currency

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  • District Court concludes a small virtual currency is a “commodity” under the Commodities Exchange Act

    Courts

    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.  

    Courts Virtual Currency CFTC Regulation Fraud Fintech

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  • Colorado regulator exempts certain cryptocurrency exchanges from money transmitter licensing requirements

    State Issues

    On September 20, the Colorado Department of Regulatory Agencies Division of Banking (Division) issued interim guidance exempting certain types of cryptocurrency exchanges from the state’s money transmitter licensing requirements. Under the interim guidance—which outlines the Division’s interpretation of Colorado’s existing Money Transmitters Act (the Act)— the Division determined that the Act regulates the transmission of money, meaning legal tender, and that cryptocurrencies are not legal tender under the Act. As a result, virtual currency exchanges operating in Colorado do not require a license if transmitting only cryptocurrencies without any legal tender issued and backed by a government (fiat currency) involved in the transaction. However, if fiat currency is present in a transaction, then a virtual currency exchange may require a license. Additionally, a virtual currency exchange must obtain a license when it performs all of the following: (i) it engages in the business of selling and buying cryptocurrencies for fiat currency; (ii) it allows a Colorado customer to transfer cryptocurrency to another customer within the exchange; and (iii) it allows the transfer of fiat currency through the medium of cryptocurrency within the exchange. If a virtual currency exchange offers the ability to transfer fiat currency through the medium of cryptocurrency, the Division encourages the exchange to contact the Division to determine whether it must obtain a license.

    State Issues State Regulators Fintech Cryptocurrency Licensing Virtual Currency Money Service / Money Transmitters

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  • New York Attorney General issues Virtual Markets Integrity Report, following cryptocurrency integrity initiative

    Fintech

    On September 18, the New York Attorney General’s office announced the results of its Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or “crypto” currencies. As previously covered in InfoBytes, last April questionnaires were sent to 13 virtual asset trading platforms to solicit information on their operations, policies, internal controls, and safeguards to protect consumer assets. The resulting Virtual Markets Integrity Report finds that virtual asset trading platforms vary significantly in the comprehensiveness of their response to the risks facing the virtual markets, and presents three broad areas of concern: (i) the potential for conflicts of interest due to platforms engaging in various overlapping business lines that are not restricted or monitored in the same way as traditional trading environments; (ii) a lack of protection from abusive trading platforms and practices; and (iii) limited protections for customer funds, such as the insufficient availability of insurance for virtual asset losses and platforms that do not conduct any type of independent auditing of virtual assets. According to the report, the Attorney General’s office also referred three platforms to the New York Department of Financial Services for potential violations of the state’s virtual currency regulations.

    Fintech State Issues State Attorney General Virtual Currency Cryptocurrency NYDFS

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  • District court rules U.S. securities law may cover initial coin offering in criminal case

    Securities

    On September 11, the U.S. District Court for the Eastern District of New York issued a ruling that the U.S. government can proceed with a case for purposes of federal criminal law against a New York-based businessman who allegedly made “materially false and fraudulent representations and omissions” connected to virtual currencies/digital tokens backed by investments in real estate and diamonds sold through associated initial coin offerings (ICOs). The defendant—who was charged with conspiracy and two counts of securities fraud for his role in allegedly defrauding investors in two ICOs—claimed that the ICOs at issue were not securities but rather currencies, and that U.S. securities law was unconstitutionally vague as applied to ICOs. However, the U.S. government asserted that the investments made in the tokens were “investment contracts” and thereby “securities” as defined by the Securities Exchange Act. The U.S. government further argued that the jury should apply the central test used by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine if a financial instrument “constitutes an ‘investment contract’ under the federal securities laws.” The judge commented that “simply labeling an investment opportunity as ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract—a security—into a currency.” Moreover, while the judge cautioned that it was too early to determine whether the virtual currencies sold in the ICOs were covered by U.S. securities law, he concluded that a “reasonable jury” may find that the allegations in the indictment support such a finding.

    Securities Courts Initial Coin Offerings Virtual Currency Fraud Securities Exchange Act Fintech

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  • CFTC wins $1.1 million judgment in cryptocurrency fraud action

    Securities

    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.

    Securities CFTC Virtual Currency Cryptocurrency Fraud

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