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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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  • FinCEN director discusses approach to virtual currency and emerging technology

    Financial Crimes

    On August 9, 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.

    Financial Crimes FinCEN Bank Secrecy Act Virtual Currency Anti-Money Laundering Combating the Financing of Terrorism SARs SEC CFTC Fintech Initial Coin Offerings

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  • Ohio governor enacts legislation recognizing blockchain transactions as enforceable electronic transactions

    State Issues

    On August 3, the governor of Ohio signed into law SB 220, which codifies that records or contracts and signatures secured through blockchain technology are enforceable electronic transactions. Specifically, SB 220 amends Ohio’s Uniform Electronic Transactions Act to state that “a record or contract that is secured through blockchain technology is considered to be in an electronic form and to be an electronic signature” and that a “signature that is secured through blockchain technology is considered to be in an electronic form and to be an electronic signature.” The amendments also create an affirmative defense or “safe harbor” to tort actions against businesses alleged to have failed to implement reasonable information security controls leading to a data breach of personal or restricted information. To qualify for the safe harbor, a business must implement and comply with a written cybersecurity program that contains specific safeguards for either the protection of personal information or the protection of both personal and restricted information.

    State Issues State Legislation Blockchain Bitcoin Virtual Currency Electronic Signatures

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  • CFTC advisory warns customers to research digital coins and tokens before purchasing

    Fintech

    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.

    Fintech CFTC Cryptocurrency Virtual Currency Initial Coin Offerings

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  • House passes bipartisan package of securities and banking bills focusing on capital market regulations

    Federal Issues

    On July 17, the House passed S. 488, the “JOBS and Investor Confidence Act of 2018” (Act) by a vote of 406 to 4. The package of 32 securities and banking bills now comprises Senate bill S. 488, which previously contained an amendment to the Securities Act Rule 230.701(e) and was included as part of the Economic Growth, Regulatory Relief, and Consumer Protection Act S.2155/P.L. 115-174. The Act focuses on capital market regulations and contains many capital formation provisions designed to, among other things, (i) expand access for smaller companies attempting to raise capital; (ii) reduce regulation for smaller companies such as providing federal stress test relief for nonbanks; (iii) revise crowdfunding provisions to allow for crowdfunding vehicles and the registration of crowdfunding vehicle advisers; (iv) exempt low-revenue issuers from Sarbanes-Oxley Act Section 404; (v) grant banks safe harbor when they keep open certain accounts and transactions at the request of law enforcement; and (vi) clarify various rules, review current securities laws for inefficiencies, and establish additional procedures focusing on virtual currency and money laundering efforts. Additional changes would amend a section of the Exchange Act governing SEC registration of individuals acting as brokers or dealers. The Fair Credit Reporting Act would also be amended to permit entities—including HUD—the ability to furnish data to consumer reporting agencies regarding an individual’s history of on-time payments with respect to a lease, or contracts for utilities and telecommunications services, provided the information about a consumer's usage of the service relates to payment by the consumer for such service or other terms of the provision of that service. S. 488 would also allow certain non-profits conducting charitable mortgage loan transactions to use forms required under the TILA-RESPA Integrated Disclosure Rule, and require the director of the CFPB to issue such regulations as may be necessary to implement those amendments. S. 488 now returns to the Senate for further action.

    Federal Issues U.S. House Federal Legislation Securities FCRA SEC Virtual Currency Stress Test Consumer Finance CFPB TRID Mortgages S. 2155

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  • Financial Stability Board publishes report discussing methods for monitoring crypto-asset risk

    Fintech

    On July 16, the Financial Stability Board (FSB) published a report, which asserts that, while “crypto-assets do not pose a material risk to global financial stability at this time,” there exists a need for “vigilant monitoring in light of the speed of developments and data gaps.” According to “Crypto-assets: Report to the G20 on work by the FSB and standard-setting bodies” (the Report), the FSB and the Committee on Payments and Market Infrastructures (CPMI) have developed a framework to monitor and assess vulnerabilities in the financial system resulting from developments in the crypto-asset markets. As previously covered in InfoBytes, the FSB earlier released a letter to G20 Finance Ministers and Central Bank Governors in March noting that “[c]rypto-assets raise a host of issues around consumer and investor protection, as well as their use to shield illicit activity and for money laundering and terrorist financing.” The Report specifically discusses actions being undertaken by international regulatory bodies, including (i) the CPMI’s investigation into distributed ledger technologies and monitoring of payment innovations; (ii) the International Organization of Securities Commissions creation of an Initial Coin Offering (ICO) Consultative Network, development of a framework for members to use when dealing with investor-protection issues stemming from ICOs, and exploration into regulatory issues regarding crypto-assets platforms; and (iii) the Basel Committee on Banking Supervision’s assessment of the materiality of banks’ crypto-asset exposures, exploration of appropriate prudential treatment of those exposures, and monitoring of crypto-asset and other financial technology developments. The Financial Action Task Force is also working separately on a report to the G20 on crypto-asset concerns regarding money laundering and terrorist financing risks.

    Fintech Financial Stability Board Cryptocurrency Virtual Currency Initial Coin Offerings

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  • Bitcoin and ether not considered securities by SEC

    Securities

    On June 14, the Director of the SEC Division of Corporation Finance, William Hinman, stated that the SEC does not consider the cryptocurrencies bitcoin and ether to be securities. In his remarks at the Yahoo Finance All Markets Summit, Hinman emphasized a number of factors that are considered when assessing whether a cryptocurrency or ICO should be considered a security. These factors include, primarily, whether a third party drives the expectation of a return—the central test used by the Supreme Court in SEC v. W.J. Howey Co.. According to Hinman, bitcoin’s and ether’s networks are decentralized without a central third party controlling the enterprise and, thus, applying the disclosure rules of federal securities laws to these cryptocurrencies would add little value to the market. Hinman did note that whether something is considered a security is not static and emphasized that if a cryptocurrency were to be placed into a fund and interests were sold, the fund would be considered a security.

    Securities Virtual Currency Blockchain SEC Cryptocurrency

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  • CFTC, NASAA enter cryptocurrency, fraud information sharing partnership; CFTC releases virtual currency derivative guidance

    Securities

    On May 21, the U.S. Commodity Futures Trading Commission (CFTC) announced it had signed a mutual cooperation agreement with the North American Securities Administrators Association (NASAA) to increase cooperation and information sharing on cryptocurrencies and other potential market fraud. The memorandum of understanding (MOU) is designed to “assist participants in enforcing the Commodity Exchange Act, which state securities regulators and state attorneys general are statutorily authorized to do alongside the CFTC,” leading to the possibility of additional enforcement actions brought under other areas of law. In order to receive the benefits—including investigative leads, whistleblower tips, complaints, and referrals provided to NASAA members by the CFTC—individual jurisdictions will be required to sign the MOU.

    The same day, the CFTC’s Division of Market Oversight and Division of Clearing and Risk (DCR) issued a joint staff advisory providing guidance on several enhancements to which CFTC-registered exchanges and clearinghouses should adhere when listing derivatives contracts based on virtual currencies. The advisory addresses the following five key areas for market participants: (i) “[e]nhanced market surveillance”; (ii) “[c]lose coordination with CFTC staff’; (iii) “[l]arge trader reporting”; (iv) “[o]utreach to member and market participants”; and (v) “Derivatives Clearing Organization risk management and governance.” According to the DCR director, the information provided is intended in part, “to aid market participants in their efforts to design risk management programs that address the new risks imposed by virtual currency products . . . [and] to help ensure that market participants follow appropriate governance processes with respect to the launch of these products.”

    Securities Fintech CFTC State Regulators Cryptocurrency Virtual Currency MOUs

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