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  • Massachusetts securities division halts five initial coin offerings

    Securities

    On March 27, Massachusetts’s Office of the Secretary of the Commonwealth Securities Division (Division) entered into separate consent orders with five companies that allegedly violated the Massachusetts Uniform Securities Act by promoting initial coin offerings (ICOs) using unregistered securities. The five companies, which conduct business in Massachusetts, offered the ICOs via websites, including social media platforms. Under the terms of the consent orders, the companies are prohibited from selling unregistered or non-exempt securities in the state and are censured by the Division.

    Visit here for additional InfoBytes coverage on ICOs.

    Securities State Issues Initial Coin Offerings Cryptocurrency Virtual Currency Enforcement

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  • FTC challenges virtual currency “chain referral schemes”—creates new working group

    Fintech

    On March 16, the FTC announced that a U.S. District Court for the Southern District of Florida granted a temporary restraining order against four individuals who allegedly promoted cryptocurrency “chain referral schemes” in violation of the FTC Act. According to the complaint, the defendants falsely promised that by paying a small sum in virtual currency to enroll, such as bitcoin or Litecoin, the participant could earn significant returns. Three of the defendants promoted schemes that claimed participants could turn $100 into $80,000 in monthly income based on recruiting additional participants, when in actuality most of the participants failed to recoup their initial investments. Additionally, the fourth defendant promoted another scheme, which promised virtual currency investors a fixed rate of return on bitcoin investments in a passive investment operation and a multilevel investment program which participants would receive a commission for recruiting more investors. The scheme allegedly ended within two months of opening and many investors failed to recover the initial investments.

    On the same day, the FTC announced a new FTC Blockchain Working Group, which will (i) “build on FTC staff expertise in cryptocurrency and blockchain technology through resource sharing and by hosting outside experts”; (ii) “facilitate internal communication and external coordination on enforcement actions and other related projects”; and (iii) “serve as an internal forum for brainstorming potential impacts on the FTC’s dual missions and how to address those impacts.” The announcement highlighted the properties of cryptocurrencies that make the payment form susceptible to scammers, including the fact that it can be transferred electronically without requiring validation from a trusted third party source. 

    Fintech Virtual Currency Enforcement FTC Courts

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  • House Financial Services Committee holds hearing on potential regulation of cryptocurrencies and ICOs

    Federal Issues

    On March 14, the House Financial Services Subcommittee on Capital Markets, Securities, and Investment held a hearing entitled “Examining Cryptocurrencies and ICO Markets” to discuss recommendations for Congress concerning the regulation of cryptocurrencies and initial coin offering ("ICO") markets. Subcommittee Chairman Bill Huizenga, R-Mich., opened the hearing by stating that “[c]ryptocurrencies and ICOs provide an innovative vehicle for startups to potentially access capital and grow their businesses,” and emphasized that potential regulation of this market should not stifle innovation in the area of digital currencies and capital formation.

    The hearing’s four witnesses offered numerous insights into the shaping of regulation in the crytopcurrency and ICO markets. The witnesses discussed emphasizing the potential of ICOs for U.S. investors, disclosures in the ICO market, and the need for regulation to be clear with definitive classification guidelines. Additionally, witnesses commented on the unanticipated negative consequences of regulation, including the risk associated with developing a regulatory framework around the cryptocurrency market since the market is still emerging. The hearing included discussion on the functions of cryptocurrency and the ICO market, including distinguishing an ICO offering from a traditional Initial Public Offering (IPO) and the different uses of “scarce tokens,” such as bitcoin, which would impact whether cryptocurrencies were regulated as commodities or securities. 

    Federal Issues Virtual Currency House Financial Services Committee Fintech Cryptocurrency Bitcoin Initial Coin Offerings

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  • District Court recognizes CFTC authority to regulate virtual currency as commodities

    Fintech

    On March 6, the U.S. District Court for the Eastern District of New York granted the CFTC’s request for preliminary injunction against defendants alleged to have misappropriated investor money through a cryptocurrency trading scam, holding that the CFTC has the authority to regulate virtual currency as commodities. The decision additionally defined virtual currency as a “commodity” within the meaning of the Commodity Exchange Act (CEA) and gave the CFTC jurisdiction to pursue fraudulent activities involving virtual currency even if the fraud does not directly involve the sale of futures or derivative contracts. However, the court noted that the “jurisdictional authority of CFTC to regulate virtual currencies as commodities does not preclude other agencies from exercising their regulatory power when virtual currencies function differently than derivative commodities.” Under the terms of the order, the defendants are restrained and enjoined until further order of the court from participating in fraudulent behavior related to the swap or sale of any commodity, and must, among other things, provide the CFTC with access to business records and a written account of financial documents.

    Find continuing InfoBytes coverage on virtual currency oversight here.

    Fintech Virtual Currency Courts CFTC Cryptocurrency Commodity Exchange Act

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  • CFTC offers large reward to “pump-and-dump” scheme whistleblowers

    Fintech

    On February 15, the Commodity Futures Trading Commission (CFTC) issued a Consumer Protection Advisory on virtual currency “pump-and-dump” schemes, which offers eligible whistleblowers between 10 and 30 percent of enforcement actions of $1 million or more, which result from the shared information. The notice cautions consumers against falling for the fraudulent “pump-and-dump” schemes, which capitalize on consumers’ fear of missing the potentially lucrative—yet volatile—cryptocurrency market. The advisory warns consumers that many of the perpetrators of these schemes use social media to promote false news reports and create fake urgency for consumers to buy the cryptocurrency immediately. Then, after the price reaches a certain level, the schemers sell their virtual currency and the price begins to fall.

    Fintech Virtual Currency CFTC Bitcoin Cryptocurrency Whistleblower Enforcement

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  • NYDFS issues policies and procedures reminder to virtual currency companies

    State Issues

    On February 7, the New York Department of Financial Services (NYDFS) issued a guidance document reminding virtual currency entities (VC entities) licensed by the state or chartered as limited purpose trust companies that they are required to have policies and procedures in place to guard against fraud, and that they should be particularly vigilant concerning efforts at market manipulation. The guidance requires VC entities to implement written policies that will (i) identify and assess fraud-related areas of risk, including market manipulation; (ii) provide procedures and controls to protect against identified risks; (iii) allocate risk monitoring responsibilities; (iv) periodically evaluate and revise risk monitoring processes to “ensure continuing effectiveness” and “compliance with all applicable laws and regulations; and (v) “provide for the effective investigation of fraud and other wrongdoing.” NYDFS also requires VC entities to submit incident reports detailing any identified wrongdoing, follow-up reports outlining any material developments, measures taken or to be taken concerning the developments, and a statement outlining any changes to the VC entity’s operations to prevent repeat occurrences.

    State Issues NYDFS Fraud Cryptocurrency Virtual Currency Fintech

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  • Market regulators discuss cryptocurrency oversight gaps during Senate Banking Committee hearing

    Fintech

    On February 6, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled, “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission” to discuss the need for unified measures to close regulatory gaps in the cryptocurrency space. Committee Chairman Mike Crapo, R-Idaho, opened the hearing by briefly discussing the rise in interest in virtual currencies among Americans, as well as investor education and enforcement efforts undertaken by the SEC and the CFTC. Crapo commented that he was interested in learning how regulators plan to safeguard investors. Sen. Sherrod Brown (D-Ohio), ranking member of the Committee, spoke about the importance of pursuing “the unique enforcement of regulatory demands posed by virtual currencies.”

    SEC Chairman Jay Clayton commented in prepared remarks that the SEC does not want to “undermine the fostering of innovation through our capital markets,” but cautioned that there are significant risks for investors when they participate in an entity’s initial coin offering (a method used to raise capital through decentralized autonomous organizations or other forms of distributed ledgers or blockchain technology) or buy and sell cryptocurrency with firms that are not compliant with securities laws. Speaking before the Committee, Clayton stated that the SEC has some oversight power in this space but supported collaborating with Congress and states on new regulations for cryptocurrency firms. “We should all come together, the federal banking regulators, CFTC, the SEC—there are states involved as well—and have a coordinated plan for dealing with the virtual currency trading market,” Clayton stressed.

    In prepared remarks, CFTC Chairman Chris Giancarlo discussed different approaches to regulating distributed ledger technologies and virtual currencies. “‘Do no harm’ was unquestionably the right approach to development of the internet. Similarly, I believe that ‘do no harm’ is the right overarching approach for distributed ledger technology,” Giancarlo said. “Virtual currencies, however, likely require more attentive regulatory oversight in key areas, especially to the extent that retail investors are attracted to this space.” 

    Giancarlo referenced a joint op-ed in which the two chairmen discussed whether the “historic approach to the regulation of currency transactions is appropriate for the cryptocurrency markets,” and offered support for “policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era.” The chairmen also agreed that the lack of a clear definition for what cryptocurrencies are has contributed to regulatory challenges, but stressed that their agencies would continue to bring enforcement actions against fraudsters. Both the SEC and CFTC have joined a virtual currency working group formed by the Treasury Department—which also includes the Federal Reserve and the Financial Crimes Enforcement Network—to discuss cryptocurrency jurisdiction among the agencies and understand where the gaps exist.

    See here for additional InfoBytes coverage on initial coin offerings and virtual currency.

    Fintech Virtual Currency Cryptocurrency Distributed Ledger SEC CFTC Senate Banking Committee

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  • House Financial Services Subcommittee conducts hearing on fintech opportunities and challenges

    Fintech

    On January 30, the House Financial Services Subcommittee on Financial Institutions and Consumer Credit held a hearing entitled “Examining Opportunities and Challenges in the Financial Technology (“Fintech”) Marketplace.” The Subcommittee issued a press release following the hearing and presented the following key takeaways:

    • “Modern developments in digital technology are changing the way in which many financial services are offered and delivered”; and
    • “Congress and the federal prudential regulators must continue to examine this innovative marketplace to understand the opportunities and challenges it presents, and to ensure that financial services entities are allowed to use fintech to deliver new products and services while also protecting consumers.”

    Opening statements were presented by several members of the Subcommittee, including Subcommittee Vice Chair Keith Rothfus, R-PA, who noted that online lending, mobile banking, and other products could bring capital back to areas deserted by traditional banks. Subcommittee Chairman Blaine Luetkemeyer, R-MO, highlighted that loan originations passed through marketplace lenders accounted for nearly $40 billion over the past ten years, with online lenders often able to offer better lending terms. Luetkemeyer also discussed the rise of mobile banking and lending and raised the question presented by some states of whether fintech companies should be required to comply with current laws that apply to similar products. He stressed that understanding fintech’s capabilities “can better create an environment that fosters certainty and responsible innovation while maintaining consumer protections.” A broad range of topics were discussed at the hearing, including the following highlights:

    • Madden v. Midland / True Lender. Companies that have chosen to partner with banks have also run into regulatory and legal roadblocks, including the recent decision in Madden v. Midland Funding, which determined that a nonbank entity taking assignment of debts originated by a national bank is not entitled to protection under the National Bank Act from state-law usury claims. (See Buckley Sandler Special Alert here.) In prepared remarks, Andrew Smith, Partner at Covington and Burling, LLP, stated that because of varying outcomes in true lender court challenges, the lack of certainty means that “market participants will no longer be willing to enter into these types of transactions, thereby depriving consumers, banks, and the economy of the many benefits of bank partnerships with fintech providers while also hampering the liquidity necessary to support a robust lending market.” Smith went on to discuss H.R. 4439, the Modernizing Credit Opportunities Act, which was introduced to “reconfirm and reinforce existing federal law with respect to a bank’s identity as the true lender of a loan with the assistance of a third-party service provider.” Smith emphasized that the legislation would “resolve any uncertainty about a bank’s ability to use third-party service providers by confirming the principle that when a bank enters into a loan agreement, it is the bank that has made the loan.”
    • Marketplace Lending. During his testimony, witness Nathaniel Hoopes, Executive Director at the Marketplace Lending Association, highlighted the role marketplace lending platforms (MPPs) have had in delivering products to underserved consumers, but emphasized that a lot of work still needs to happen for more of the “broad American ‘middle class’ to fully realize and benefit from the potential of MPPs specifically and fintech more broadly.” He also expressed support for the Special Purpose National Bank charter currently under consideration by the OCC.
    • Regulatory Sandboxes. Witness Brian Knight, Director of the Program on Financial Regulation and Senior Research Fellow at the Mercatus Center at George Mason University, suggested in his prepared remarks various methods to improve the current regulatory environment, and opined that lawmakers could allow firms that participate in a regulatory sandbox program and comply with its requirements to avoid liability as long as the firm makes “customers whole if the firm causes harm owing to a violation of the law.” Knight added that states could be allowed to grant special non-depository charters similar to those offered by the OCC. And while witness Professor Adam J. Levitin of the Georgetown University Law Center agreed that sandboxes would allow companies to explore new ideas with the understanding that customers must be protected, he cautioned that the fragmentation of the regulatory system around fintech makes it hard for experimentation, and that risk would need to be regulated.
    • Virtual Currencies. Knight discussed his concerns with initial coin offerings (ICOs) and commented that while ICOs “may enable firms to access capital more effectively than traditional methods, there are significant concerns that they are being used by both outright frauds and well-meaning but ignorant firms to obtain capital in contravention of existing laws governing the sales of securities, commodities futures contracts, and products and services.” However, Knight testified that despite the potential for risk, peer-to-peer payments, cryptocurrencies, and other innovations demonstrate potential, and that innovative lenders are replacing banks in communities where it is no longer profitable for those banks to serve.

    Inconsistent Regulations. During his testimony, witness Brian Peters, Executive Director at Financial Innovation Now, advocated for improved coordination among regulators and stressed that the “current structure is needlessly fragmented and inconsistent among federal regulators, and varies widely across state jurisdictions.” Peters also commented on the need to modernize the regulatory structure to keep pace with innovation and meet consumers’ needs.

    Fintech House Financial Services Committee Marketplace Lending True Lender Virtual Currency Bank Regulatory Usury Third-Party Madden

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  • SEC halts allegedly fraudulent ICO

    Securities

    On January 30, the Securities and Exchange Commission (SEC) announced it obtained a court order preventing an allegedly fraudulent initial coin offering (ICO) by a Dallas-based company. According to the complaint filed on January 25, the company pitched its ICO by depicting itself as a “decentralized bank” that could automatically trade in multiple cryptocurrencies and provide a variety of consumer banking products and services based on over 700 different virtual currencies. The SEC alleges that the company failed to properly register the ICO and made materially false statements in its advertisements, such as: (i) the company’s purchase of an FDIC-insured bank; and (ii) the availability of a company-branded VISA card allowing for payment of goods and services using different virtual currencies held in a checking account with the company. The company also purportedly failed to disclose the criminal background of certain executives. According to the SEC, the District Court approved an emergency asset freeze and placed the company in receivership. Among other things, the SEC is seeking a permanent injunction and the release of profits associated with the fraudulent activity, plus interest and penalties.

    Securities Initial Coin Offerings Virtual Currency Fintech

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  • Maryland issues bipartisan consumer protection recommendations

    State Issues

    On January 26, the Maryland Financial Consumer Protection Commission (the “Commission”) and ranking officials from the Maryland legislature announced bipartisan “Interim Recommendations” of the Commission for State and local action in response to the federal government’s “efforts to change or weaken […] important federal consumer protections.” New legislation in response to the recommendations is expected to be released in the near future. Key recommendations include, among other things: (i) requiring credit reporting agencies to provide an alert of data breaches promptly and provide free credit freezes; (ii) adopting new financial consumer protection laws in areas where the federal government may be weakening oversight; (iii) addressing potential issues with Maryland’s current payday and lending statutes; (iv) adopting the Model State Consumer and Employee Justice Enforcement Act that addresses forced arbitration clauses; and (v) adopting new laws that address new risk, such as, virtual currencies and financial technology.

    State Issues State Legislation Consumer Finance Data Breach Payday Lending Arbitration Virtual Currency Fintech Credit Reporting Agency Security Freeze

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