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Senate holds hearing on the role of digital assets in illicit finance
On March 17, the Senate Banking, Housing, and Urban Affairs Committee held a hearing titled “Understanding the Role of Digital Assets in Illicit Finance” to consider the risks crypto technology and digital assets pose for consumers and the financial system. The Committee heard from several witnesses, including FinCEN’s Former Acting Director, Deputy Director/Digital Innovation Officer Michael Mosier, who stressed that policymakers should focus on finding a balance that does not only “chase bad actors but also prevents exploitation of the vulnerable from the start.” Chairman Sherrod Brown (D-OH) opened the hearing by explaining that the “dollar has safeguards to protect against crime and illicit activity” because companies dealing in real money “are required to know their customers, and report suspicious transactions.” In contrast, digital assets “make it easier for money launderers to use webs of transactions across the globe to cover their tracks” and hinders law enforcement agencies’ ability to trace illicit funds. Brown cautioned that “lax rules and little oversight” are providing bad actors more opportunities to “hide and move money in the dark” using cryptocurrency. He stressed, however, that President Biden’s recent executive order, which outlined a coordinated approach to digital asset innovation (covered by InfoBytes here), will “drive progress on this issue” and “jumpstart a coordinated strategy from law enforcement and regulators to fight bad actors who want to use crypto.” Ranking Member Pat Toomey (R-PA) took a different view, noting that the “traceable nature of many cryptocurrencies” can also support the detection and prevention of illicit crime, which is “a factor making [cryptocurrency] terribly risky to utilize for criminal purposes.” He also expressed concerns that the lack of regulatory clarity surrounding digital assets has driven innovation abroad.
Witnesses provided various recommendations designed to, among other things, reduce the risk of sanctions evasion through digital assets, as well as improve detection, disruption, and deterrence of the illicit use of digital assets. While one witness stated that “transparency of blockchains enhances the ability of policymakers and law enforcement to detect, disrupt, and ultimately, deter illicit activity,” another witness cautioned that “[e]ven with the latest blockchain analytics, investigations can take years to complete,” particularly because “prosecutors must demonstrate that an identifiable person is behind the criminal activity.”
Waters establishes Digital Assets Working Group
On June 16, Chairwoman of the House Financial Services Committee Maxine Waters (D-CA) announced the organization of the “Digital Assets Working Group of Democratic Members” to develop “legislation and policy solutions” on issues emerging in the digital asset space, including those related to (i) the regulation of cryptocurrency; (ii) the use of blockchain and distributed ledger technology; and (iii) the potential development of a U.S. central bank digital currency (see InfoBytes coverage on matters related to a CBDC here). During the first hearing held by the Task Force on Financial Technology, Waters stated that the working group will “focus on making sure there is responsible innovation in the cryptocurrency and digital asset space,” noting that “[a]s cryptocurrencies, central bank digital currencies and other digital assets enter the mainstream, the Committee will look at how digital assets have begun to enter many aspects of our lives—from payments to investments to remittances—and consider how to devise legislation to support responsible innovation that protects consumers and investors while promoting greater financial inclusion.”
SEC issues $18.5 million civil penalty for unregistered digital token offering
On June 26, the SEC announced a settlement with two offshore entities, resolving allegations that the entities violated federal securities laws by raising more than $1.7 billion in unregistered digital token offerings. As previously covered by InfoBytes, in October 2019, the SEC obtained a temporary restraining order, halting the offerings. According to the SEC, the entities violated Sections 5(a) and 5(c) of the Securities Act by failing to register its offers and sales of securities with the SEC. Prior to the restraining order, the entities had sold approximately 2.9 million digital tokens worldwide, including more than 1 billion tokens to 39 U.S. purchasers. The settlement requires the entities to return more than $1.2 billion to investors in “ill-gotten gains” from the token offerings. Additionally, the parent company is required to pay an $18.5 million civil penalty and give proactive notice to the SEC before participating in any digital asset issuances for the next three years. The entities entered into the settlement without admitting or denying the allegations in the SEC’s complaint.
SEC settles with blockchain company over unregistered ICO
On February 19, the SEC announced a settlement with a blockchain technology company resolving allegations that the company conducted an unregistered initial coin offering (ICO). According to the order, the company raised approximately $45 million from sales of its digital tokens to raise capital to develop a digital asset trade-testing platform and to build a cryptocurrency-related data marketplace. The SEC alleges that the company violated Section 5(a) and 5(c) of the Securities Act because the digital assets it sold were securities under federal securities laws, and the company did not have the required registration statement filed or in effect, nor did it qualify for an exemption to the registration requirements. The order, which the company consented to without admitting or denying the findings, imposes a $500,000 penalty and requires the company to register its tokens as securities, refund harmed investors through a claims process, and file timely reports with the SEC.
SEC commissioner proposes cryptocurrency safe harbor
On February 6, SEC Commissioner Hester M. Pierce announced her proposal for a three-year safe harbor rule applicable to companies developing digital assets and networks. Pierce suggested that not only would the rule provide regulatory flexibility “that allows innovation to flourish,” but it would also protect investors by “requiring disclosures tailored to their needs” while still maintaining anti-fraud safeguards, allowing investors to participate in token networks of their choice. Proposed Securities Act Rule 195 would allow companies to sell or offer tokens without being subject to the Securities Act of 1933, and without the tokens being subject to the registration requirements of the Securities Act of 1934. In order to qualify for these exemptions, the proposed rule requires that a company developing a network must, among other things, (i) “intend for the network on which the token functions to reach network maturity…within three years of the date of the first token sale”; (ii) disclose key information on a freely accessible public website,” including applicable source code and descriptions of how to search and verify transactions on the network; (iii) offer and sell its tokens in order to allow access to or development of its network; (iv) make “good faith and reasonable efforts to create liquidity for users”; and (v) “file a notice of reliance” with the SEC’s EDGAR system within 15 days of the company’s first token sale made in reliance on the safe harbor. Pierce suggested that the three-year grace period for qualifying companies would allow time for the development of decentralized or functional networks, and, at the end of the three years, a successful network’s tokens would not be regulated as securities.
SEC suit alleges fraudulent ICO
On January 21, the SEC announced that it filed suit in the U.S. District Court for the Eastern District of New York against a blockchain company and the company’s founder (defendants) for allegedly “conducting a fraudulent and unregistered initial coin offering (ICO).” The SEC alleges, among other things, that from 2017 until 2018, the defendants raised $600,000 from nearly 200 investors through promoting an ICO of digital asset securities called “OPP Tokens,” using material misrepresentations to create the false impression that the defendants’ platform was creating notable growth in the company. The defendants marketed the tokens by making misstatements to potential investors, greatly exaggerating the numbers of providers that were “willing to do business on, and contribute content to, [defendants’] blockchain-based platform.” The complaint also alleges that in marketing the ICO, the defendants provided a catalog of small businesses eligible to use the defendants’ platform that numbered in the millions, in order to create the false impression that the platform had a huge base of users. In reality, the catalog was not compiled by the defendants, but was simply acquired from a vendor. Additionally, the SEC alleges that the defendants provided numerous customer reviews in its promotions to create the impression that the platform had many users creating content, which were actually reviews stolen from a third-party website. The SEC charges that in addition to the above allegations, the defendants misrepresented that they had filed an SEC registration statement for the ICO. The SEC seeks injunctive relief, disgorgement of profits, civil money penalties, and a permanent bar preventing the founder from serving as officer or director of any public company.
SEC obtains temporary injunction against unregistered digital token offering
On October 11, the SEC announced it obtained a temporary restraining order through an emergency action filed against two offshore entities that allegedly raised more than $1.7 billion of investor funds. According to the complaint, the entities sold approximately 2.9 million digital tokens worldwide, including more than 1 billion tokens to 39 U.S. purchasers. The entities promised that the tokens would be delivered upon the launch of its own blockchain by the end of October 2019. The SEC alleges the entities violated Sections 5(a) and 5(c) of the Securities Act by failing to register its offers and sales of securities with the SEC. In addition to the emergency relief, the SEC is seeking a permanent injunction, disgorgement, and civil penalties against the offshore entities.
Illinois creates Blockchain Technology Act
On August 23, the Illinois governor signed HB 3575 to create the Blockchain Technology Act. Under the Act, “blockchain” is defined as “an electronic record created by the use of a decentralized method by multiple parties to verify and store a digital record of transactions which is secured by the use of a cryptographic hash of previous transaction information.” Among other things, the Act specifies permitted uses of blockchain technology in transactions and proceedings, such as in smart contracts, electronic records and signatures, and provides several limitations, including a provision stipulating that if a law requires a contract or record to be in writing, the legal enforceability may be denied if the blockchain transaction cannot later be accurately reproduced for all parties. Moreover, local government units are prohibited from imposing taxes or fees for the use of blockchain technology, and cannot require a person or entity to obtain a certificate, license, or permit in order to use a blockchain or smart contract. HB 3575 takes effect January 1, 2020.
Florida establishes blockchain task force
On May 23, the Florida governor signed SB 1024, which establishes the “Florida Blockchain Task Force” within the Department of Financial Services to “explore and develop a master plan for fostering the expansion of the blockchain industry in the state, to recommend policies and state investments to help make this state a leader in blockchain technology, and to issue a report to the Governor and the Legislature.” Within 90 days of signing, the bill requires that a majority of the 13 required members of the task force must be appointed and the task force must hold its first meeting. The task force is required to, among other things, study blockchain technology and submit a report to the Governor and the Legislature with recommendations for implementing blockchain technology in the state and recommendations for specific implementations to be developed by relevant state agencies. The bill took effect on May 23.
Washington state recognizes distributed ledger technology
On April 26, the Washington state governor signed SB 5638, which recognizes the validity of distributed ledger technology. Intending to expand the scope of the existing federal ESIGN Act, the bill adds a new chapter to the Revised Code of Washington, defining distributed ledger technology as “any distributed ledger protocol and supporting infrastructure, including blockchain, that uses a distributed, decentralized, shared, and replicated ledger.” The bill prohibits an electronic record from being denied “legal effect, validity, or enforceability solely because it is generated or stored using distributed ledger technology.” The bill is effective July 28.