Cryptocurrencies and the Regulatory Challenges Around Them
The complexity and global popularity of cryptocurrencies, or digital assets, has initiated cooperative efforts between the SEC and CFTC to understand and regulate these products. The agencies have jointly testified before Congress and displayed interest in developing meaningful regulations; both agencies have promised additional working groups to pursue joint regulations.
On January 24, 2018, the SEC and CFTC issued a joint statement to describe the efforts both agencies are taking to regulate this market and root out fraud in the offer and sale of digital assets. The SEC’s Division of Investment Management also issued a letter raising concerns about registered investment companies’ investments in cryptocurrencies and cryptocurrency-related assets.
In January 2018 the CFTC filed two complaints in the United States District Court Eastern District of New York (USDCEDNY), CFTC v. Dillon Michael Dean and The Entrepreneurs Headquarters Limited and CFTC v. Patrick K. McDonnell and Cabbagetech, Corp. d/b/a Coin Drop Markets, sending a strong message to alleged fraudulent actors that the agency believes it has jurisdiction over cryptocurrencies under the Commodity Exchange Act (“CEA”), notwithstanding that the activity is unrelated to futures products.
Relying on the CEA definition of a commodity, on March 6, 2018 the court upheld the CFTC’s authority to exercise its enforcement power over fraud of cryptocurrencies sold in interstate commerce and granted the CFTC an injunction against Patrick McDonnell and Cabbagetech, Corp. The court held that cryptocurrencies are commodities under applicable law, and that the CFTC has standing to sue persons for fraud relating to spot sales of cryptocurrencies, even where such sales do not involve the sale of futures or derivatives contracts. The court, however, acknowledged that the CFTC’s oversight of spot cryptocurrencies is limited and not exclusive. Other regulators might include state and federal criminal authorities, the Department of Justice, the SEC, FinCEN, and the states.
The SEC has announced it will continue to handle cryptocurrency offerings based on a “facts and circumstance” test that judges each case individually for determining whether the offering is a security subject to SEC regulation or, if not, which regulatory agency, if any, has jurisdiction.
At the same time the SEC has divided its enforcement actions against Initial Coin Offering (“ICO”) issuers into two “buckets” — those whose offerings are viewed by the agency as “outright frauds,” and those whose offerings need to be registered as securities with the SEC.
For investment advisors, rules pertaining to conduct requirements for advice provided to clients are currently in place per the Advisors Act of 1940.
It should be noted that both FINRA and the NFA are looking for direction from the SEC and CFTC, respectively. However, regulations such as due diligence of products sold, policies and procedures, suitability, electronic records and supervision are currently in place to regulate firm conduct as it relates to the sale of any product, including cryptocurrencies.
It seems that the regulators need to cooperatively, and as soon as possible, lay out, guidance and rules that bring clarity to everyone in the cryptocurrency ecosystem about the expectations of regulations. While most prosecutors can put together a fraud case for taking money unlawfully, it’s the fundamentals (registration, customer funds, capital, underwriting, trading, etc.) that require interpretation and codification adopted under a transparent and proper rulemaking structure.
How Oyster Can Help
Oyster can help firms view the opportunities and risks associated with cryptocurrencies from a strategic, operational, and compliance standpoint for the emerging cryptocurrency industry and for exchanges, broker-dealers, FCMs and RIAs.
For more information about how Oyster can assist your firm or to request a consultation, complete our contact form or call (804) 965-5400 and one of our Relationship Managers will be happy to help you.
Bill Reilly is an Associate Director at Oyster Consulting. Bill provides essential compliance services to broker-dealers, investment advisers and industry professionals, leveraging his examination expertise and relationships with state and federal regulators and self-regulatory organizations to guide clients through both proactive and reactive regulatory processes and compliance issues.
Don Horwitz is an independent consultant associated with Oyster Consulting. During his thirty-plus years in the industry, Mr. Horwitz focused on assisting futures commission merchants (FCMs), broker-dealers, derivatives exchanges and their central counterparty clearinghouses (CCPs). He served as general counsel and/or chief compliance officer to three FCMs (through mergers and acquisitions), president of a broker-dealer and several developing exchanges.