Regulatory and Compliance Updates — July 2018
This post is the latest in our updates on regulatory and compliance developments in the blockchain and cryptocurrency industries, covering the entire month of July.
🇺🇸 United States
Bitcoin ETFs
On July 26, the Securities and Exchange Commission (“SEC”) rejected an application by the Winklevoss twins to create an exchange traded fund for bitcoin, on the grounds that bitcoin is subject to market manipulation and lacks liquidity. One SEC commissioner, Hester Peirce, dissented from the ruling, arguing that the ruling will dampen innovation and ultimately harms investors by slowing down the institutionalization of the bitcoin markets. (link) For an analysis of the implications of this ruling, see this post from Ilan Sterk.
This ruling will not be the last word on this issue, as the Winklevoss ETF was not the only application of this type that pending before the SEC. On July 23, the SEC postponed its decision on five ETF proposals submitted by Direxion Investments until September 21. (link) The SEC is also scheduled to rule on ETFs proposed by Van Eck and SolidX in August. On July 23, Bitwise, a crypto investment startup, announced that it filed an application with the SEC for an ETF that would track the returns of ten major cryptocurrencies. (link)
Regulatory Agencies
The IRS made two announcements on July 2 regarding cryptocurrency/blockchain. First, the agency announced that it is initiating a new audit campaign targeting tax noncompliance related to digital currency. The IRS encouraged all taxpayers who have unreported virtual currency transactions to correct their returns as soon as possible, but also noted that there are no plans for a specific voluntary disclosure program. In its second announcement, the IRS announced that it is joining an international coalition of tax authorities from countries including Australia, Canada, the Netherlands and the UK, who will work together to investigate crimes and money laundering related to cryptocurrency by sharing information, conducting operations and working together to build capacity. The IRS also indicated that they are continuing to work on future guidance (the last major guidance from the agency came out in 2014). (link)
On July 11, President Trump issued an executive order creating a Task Force comprising various regulatory agencies, particularly the Department of Justice (“DOJ”) which is supposed to investigate and prosecute fraud that targets the public and the government. In his remarks at the press conference announcing the task force, SEC chairman Jay Clayton highlighted the SEC’s actions to shut down fraudulent ICOs. One of the purposes of the task force, which could be beneficial to the cryptocurrency industry, is to encourage coordination among the various U.S. regulators and avoid prosecutors “piling on” and taking multiple actions against the same conduct. (link)
The DOJ also sparked some discussions related to cryptocurrency in its July 14th announcement of indictments against Russian intelligence officers who are accused of tampering with the 2016 U.S. elections. According to the indictments, the Russian operatives used bitcoin to fund their hacking efforts. Some members of Congress reacted by criticizing the crypto industry. (link)
In a potentially constructive development, the head of the Consumer Financial Protection Bureau (“CFPB”) announced that the CFPB is working to create a regulatory sandbox for blockchain companies. In a July 18th press release, Paul Watkins was named to head the initiative. Watkins was previously in charge of Arizona’s FinTech Regulatory sandbox. (link)
FINRA, the self-regulatory organization covering most participants in the US financial markets, asked its members on July 6 to promptly notify it if they are involved or plan to become involved in any activities related to digital assets. The request is part of the organization’s ongoing efforts to monitor developments in the digital asset marketplace and ascertain the extent of its member’s involvement. FINRA also reminded its members to consider all applicable laws when engaging in these activities. (link)
The Commodity Futures Trading Commission (“CFTC”) issued an advisory letting ICO investors know that they should be cautious when they purchase digital tokens. This is the fourth CFTC advisory warning of various risks involving cryptocurrencies. (link)
In previous updates, we noted that the SEC has been active in prosecuting companies that “pivoted to blockchain” and added blockchain to their company names or business descriptions in order to benefit from the hype surrounding the industry. Continuing this line of enforcement, the SEC charged two people on July 2nd with making illegal sales of stock in a company called UBI Blockchain Internet Ltd. (formerly called “J.A. Energy”), which had once claimed to be in the business of “designing climate-controlled units for the distributed production of energy” before announcing it had entered the blockchain business in early 2017. The defendants were associated with the company’s law firm and had received compensation in the form of restricted shares that were supposed to only be resold at a fixed price of $3.70 per share. This restriction was described in UBI’s registration statement and other SEC filings. Instead, the defendants sold the shares for prices between $21 and $48 per share. As a result, the SEC complaint claims that these sales were not done under the registration statement and were therefore an illegal sale of unregistered shares. The defendants have agreed to return $1.4 million and pay $188,682 in penalties; the settlement is subject to court approval. (link)
Congress
On July 18, Congress held two hearings related to cryptocurrency, one at the House Committee on Financial Services and the other, naturally, at the House Committee on Agriculture (to be fair, the house Committee on Agriculture does engage in general oversight of the CFT and commodities regulation). Among other members making negative comments, Congressman Brad Sherman suggested banning all mining and purchases of bitcoin. At the Agriculture Committee hearing, the head of the Federal Reserve made some negative comments about cryptocurrency’s alleged usefulness to criminals, but also indicated that the Fed does not believe it has jurisdiction over this area and does not plan on taking any action to regulate it. A representative of the CFTC cautioned other regulators against taking hasty regulatory action. (link)(link)
On July 18, two congressmen filed a bill called the FinCEN Improvement Act that, if signed, would specifically mandate that the Financial Crimes Enforcement Network (“FinCEN”) focus specifically on cryptocurrencies and would expand FinCEN’s duties and powers to cover “emerging technologies or value that substitutes for currency.” (link)
States
In California, a defendant who ran a business exchanging bitcoins for cash was convicted and sentenced to one year of prison for the unlicensed operating of a digital currency exchange and a money laundering charge. The government had requested two and a half years of prison, but the defense, apparently successfully, argued that the operation was so unsophisticated that there was little risk the defendant would do this again. With respect to the money-laundering charge, the defendant was approached by an undercover DEA agent who wanted to exchange bitcoins for cash, and in the course of the discussions told the agent that she did not want to know the source of the bitcoins and that she did not keep track of whether transactions exceeded $10,000. The agent also specifically told the defendant that the bitcoins came from the sale of drugs. In addition to this undercover sting operation, the defendant was also convicted of exchanging over $6 million in bitcoins for the operator of a large darknet drug vendor. (link)
On July 26, the investor protection unit of Delaware’s state department of justice used a unique enforcement tactic, emailing users of the Poloniex exchange based in the state to ask them if they have had any difficulties with their account. Recent news reports have indicated that the exchange has frozen some user accounts and not responded to inquiries from the investors. The Delaware DOJ located Delaware users “based on [its] research”. (link)
In New York, the operator of two cryptocurrency exchanges pled guilty to various crimes, including securities fraud and obstruction of justice. Among other things, the defendant allegedly lied to users about how many bitcoins remained available after one of the exchanges was hacked. (link) On the more positive side of things, the payments processor BitPay received a BitLicense from New York’s regulator, becoming the eighth company to receive the license to operate in the state. (link)
In an uncommon victory for cryptocurrency businesses, two companies succeeded in getting cease and desist orders that were issued by the state of South Carolina overturned two cease and desist orders against blockchain companies (we originally noted these cases here). The reason for the dismissal wasn’t specified in the publicly filed documents. (link) Texas regulators, on the other hand, issued a cease and desist order to eight different individuals and entities involved in several different cryptocurrency endeavors, including an ICO, a bounty program and a collaborative mining effort, which were all based in Utah but allegedly also targeted Texas residents. The cease and desist order accuses the respondents of offering unregistered investment contracts in the state, as well as making various fraudulent statements (among the false statements were claims that the operation was “in compliance with securities laws” and “works to stay ahead of cryptocurrency regulation”), as well as failing to disclose required information. (link)
Litigation: CFTC vs. McDonnell
One important court case that has been winding its way through the U.S. courts is the CFTC’s prosecution of a defendant named Patrick K. McDonnell, who is accused of operating a fraudulent ICO. This is the first case that raised the question of whether the CFTC has jurisdiction over cryptocurrencies. The CFTC claims that McDonnell’s alleged fraud is within its jurisdiction because cryptocurrencies are “commodities”, while McDonnell argued that cryptocurrencies do not fall within the relevant definition. The federal court for the Eastern District of New York made an initial ruling on this issue in favor of the CFTC back in March. However, on July 13 the court delayed the final decision in the case as the judge scheduled an additional round of briefings and a final hearing to determine how the CFTC calculated its claimed damages and monetary penalties. The hearing is scheduled to occur on August 28. Any final ruling could be appealed, in which case a higher court would have the opportunity to rule on the threshold question of whether the CFTC has jurisdiction over cryptocurrencies. (link)
International
The Financial Stability Board, which is an international body that monitors and makes recommendations about the global financial system, issued a report on July 16 to the G20 Ministers of Finance and Central Bank Governors setting forth their research relating to cryptocurrency, particularly regarding how to monitor the level of risks these assets present to financial stability. The G20 group had previously asked the FSB, along with other international standard-setting bodies to provide reports on their cryptocurrency work by July 2018. The report indicates that cryptocurrencies and related platforms do not currently present high levels of risk to the international economy overall (but should be vigilantly monitored to ensure that this remain true). The framework identifies metrics that the FSB could monitor in order to highlight any risks in a timely manner, including the size and rate of growth of the crypto-asset markets and the degree to which mainstream financial institutions are exposed to these markets. For the latter, the FSB proposes to measure how much leverage cryptocurrency related businesses have taken on and the size of investments made by financial institutions in the crypto markets. (link)
The Financial Action Task Force (“FATF”), which is in charge of international anti- money laundering and terrorist financing standards, also issued a report to the G20. In the report, the FATF outlined the work it has been doing with respect to virtual currencies. This work includes developing a comprehensive approach to the use of virtual currency in crime and money laundering, actively monitoring the risks involved and formulating additional guidance. The report contains a short summary of current regulatory approaches taken by countries, which break down to a few categories: (i) countries that have prohibited the use of virtual currencies or forbidden financial institutions from dealing with them, (ii) countries applying existing AML-CTF laws to intermediaries and exchanges dealing in virtual currencies, (iii) countries that don’t apply all current AML-CTF laws to virtual currencies but do require suspicious transaction reporting and (iv) countries that are still in the process of establishing their laws. The report also indicates that the FATF is working with national law enforcement agencies to improve their operational capacity and identify tools that can facilitate investigations.
After the meetings and receiving these reports, the G20 Finance Ministers and Central Bank Governors issued a statement discussing their plans for the upcoming months. Notably, the statement reiterates that the body expects FATF to issue guidance clarifying how its standards apply to crypto-assets by October 2018. Clarifying these standards could have a large impact on the industry, as many countries are likely to adjust their national policies in order to comply to the updated guidance. According to the FATF report, the body will hold meetings in September and consider detailed proposals in October 2018 in order to meet the deadline. (link)
🇰🇷 South Korea
South Korea saw a series of moves in the direction of legitimizing the blockchain industry and adding additional regulations. On July 5, local news outlets reported that several government ministries were working to adopt a new classification scheme for the blockchain industry that would provide official definitions of cryptocurrency exchanges, DApps, and blockchain systems construction and transactions. (link) On July 11, National Assembly members introduced draft legislation that would govern cryptocurrencies, ICOs and blockchain technology generally. Members affiliated with the current government and several opposition parties each presented their own bills. Thus far, none of these bills has become law. (link) However, the main financial regulator, the Financial Services Committee (the “FSC”) has urged the nation’s lawmakers to pass the law as soon as possible, arguing that such regulation is necessary to prevent security flaws and money-laundering (link). This month, the FSC also set up a dedicated cryptocurrency department that will focus on consumer protection and also developing policy initiatives to respond to new challenges (link).
Korean Authorities were also active in enforcement during July, among other things, launching an investigation against an ICO investment scam that claimed to have found a shipwrecked Russian armored cruiser that sank in 1905 while carrying $131 billion worth of gold. The company allegedly offered to reimburse token purchasers with gold from the ship; the ICO raised $53.7 million. The CEO subsequently admitted that it is unclear that anything of value is actually on the ship. As an initial step, the authorities issued a travel ban on the CEO. (link)
The government also announced that it was introducing legislation that would prevent cryptocurrency exchanges from receiving tax benefits that are currently offered to small and medium startup companies. A draft bill is scheduled to be presented by August 31. Blockchain companies working on research and development may still be eligible for the benefits. (link)
🇯🇵 Japan
According to local media reports, Japan’s main financial services regulator, the FSA, is considering changing the legal framework under which it regulates crypto exchanges. Currently, Japan primarily regulates cryptocurrency assets under the Payment Services Act, which was amended in April 2017 to specifically include rules covering “virtual currency exchange services.” This law covers payments of electric money generally. Under the new suggested approach, the FSA would regulate cryptocurrency exchanges under the Financial Instruments and Exchange Act, which provides for more stringent regulation and consumer protection. This change, if it is implemented, would represent a shift in thinking from the FSA, viewing cryptocurrencies as financial instruments rather than an electronic means of payment and would result in significantly stricter regulations on cryptocurrency exchanges. (link) Later in the month, the FSA reshuffled its internal organizational structure, replacing various bureaus with new ones that are designed to respond to cryptocurrency and other fintech developments. (link)
The Japan Virtual Currency Exchange Association, which is a self-regulatory organization comprising most of the country’s regulated exchanges, announced that it is considering requiring its members to place limits on margin trading (trading using borrowed funds). The restriction would prevent traders from borrowing an amount that is more than four times the amount of their deposit. (link) The organization is also considering requiring its members to implement restrictions that would prevent smaller traders from trading at high volumes. (link) In June, the association proposed various other restrictions, including a potential ban on privacy-oriented tokens like Monero and Zcash.
🇨🇳 China
A vice governor of the People’s Bank of China threatened to “crush” unauthorized ICO projects that moved oversees as a result of the country’s general ban on ICOs but continue to make themselves available to the Chinese market. (link) Authorities seized $1.5 million in cryptocurrencies as part of a crackdown on gambling during the World Cup (link) and, in a separate case, arrested 20 people involved a scheme that highjacked over a million computers and used them to mine cryptocurrencies without their owners’ knowledge (link) The Shenzen Stock Exchange launched a probe of a video-streaming provider which announced that it would launch a console that can mine cryptocurrency with its unused broadband that is not being used for streaming videos. The stock exchange’s inquiry is focused on whether the company really has the capacity to create the product described, as well as questioning whether the product is compliant with Chinese regulations. (link)
🇻🇳 Vietnam
Vietnam’s securities regulator issued a warning that the firms it regulates should not engage in activities related to cryptocurrencies, including issuance, transaction and brokerage. The country also imposed a ban on importing mining devices. (link)
🇵🇭 Philippines
On July 6, the Philippine central bank approved two license applications filed by cryptocurrency exchanges, bringing the total number of licensed exchanges to four. (link) Media reports indicated that the country intends to make a profit of around $67 million from licensing fees. (link)
🇹🇭 Thailand
Thailand’s ICO rules, which were initially announced in May, took effect on July 16. The rules require ICOs to be done through regulated ICO portals, which will be required to screen projects. The Thai SEC will begin evaluating applications from portals, which will be required to have a minimum registered capital of $150,000 and sufficient resources to evaluate an ICO’s business plan, project structure, technical capacity and source code. ICO issuers will only permitted to accept Thai baht and seven cryptocurrencies (bitcoin, bitcoin cash, Ethereum, Ethereum classic, litecoin, XRP and lumens). (link)
🇪🇺 European Union
On July 9, the EU’s Fifth Anti-Money Laundering Directive came into force. The new rules impose stricter AML/KYC rules on virtual currency exchange platforms and custodian wallet providers, including registration requirements and transaction monitoring arrangements with regulators. (link)
🇨🇭 Switzerland
A Swiss stock exchange announced plans to launch a blockchain-based exchange for trading digital assets such as ICO tokens. (link) Meanwhile, securities regulators announced that they are investigating a $100 million ICO for accepting public deposits without authorization. Under Swiss guidelines issued in February 2018, an ICO operator is required to get a banking license if it accepts public deposits and has obligations to participants as a result of the ICO. (link)
🇲🇹 Malta
Malta passed its package of blockchain-related bills into law on July 4. (link) The new laws include a framework for disclosure to investors regarding ICO tokens that do have financial investment value but do not fall within the classic definitions of a security. However, on July 20 the Malta Financial Services Authority released a statement that the newly-passed laws are not yet fully operational and that the authority is not prepared to receive requests for approval and authorization. (link)
The Malta Stock Exchange announced a plan to set up a regulated exchange that would trade securities tokens as well as other crypto-assets. (link)
🇫🇮 Finland
The central bank of Finland issued a highly-critical research report on cryptocurrencies generally, arguing that the concept is a “fallacy” and “great illusion.” It is not clear whether this report will have any impact on the legality of cryptocurrency activities in that country. (link)
🇬🇧 United Kingdom
The UK’s Financial Conduct Authority (“FCA”) accepted 29 businesses into its “regulatory sandbox”, with 40% of them coming from the crypto/blockchain industry. The sandbox allows companies to test products and services in a controlled environment, using a customized regulatory environment for each test. This is the first time the FCA has accepted crypto companies into its sandbox. (link)
A local UK court, for the first time, ruled that a local police department was permitted to confiscate 295 bitcoins from a convicted money-launderer. The police had found a digital key that accessed the bitcoin during a search of the defendant’s property; they then set up their own bitcoin wallet and used an offshore exchange to transfer and convert the bitcoin into pounds. The police department will be permitted to keep 18.8% of the proceeds for its operating budget. (link)
🇷🇴 Romania
On July 5, Romania’s finance ministry released a draft bill to regulate electronic money, including cryptocurrency. Under the bill, an entity that wants to issue e-money is required to have their tax and legal records verified and receive approval from Romania’s central bank. (link)
🇺🇿 Uzbekistan
Uzbekistan’s government issued a decree that is intended to encourage development and integration of blockchain technology. Among other things, the decree provides that entities that want to engage in cryptocurrency activities will need to receive licenses, but also will receive tax benefits. (link)
Blockchain and Banks — 🇮🇳 India and 🇨🇱 Chile
The struggle between banks and blockchain companies continued throughout the world. In India, the supreme court yet again denied a request for an interim order pausing the central bank’s ban on financial institutions doing business with cryptocurrency companies (link). As a result, the ban went into effect on July 5, with at least one exchange halting all fiat operations in response. (link) The court will hold a final hearing on the ban on September 11. (link)
In Chile, however a court of appeals ruled that a state-owned bank should reopen a crypto exchange’s deposit account, arguing that refusing to do so was against the country’s constitutional provisions guaranteeing equality before the law. The country’s anti-monopoly court made similar rulings in April. (link)
🇧🇲 Bermuda
In a possible solution to the banking and blockchain problem, on July 3, Bermuda’s government proposed a bill that would create a new legal class of bank that will be dedicated specifically to fintech and blockchain companies, as the country’s existing banks have been hesitant to engage with client from these industries. (link) On July 13, the government also introduced new draft regulations for ICOs that cover minimum required information for projects and the necessary compliance measures that issuers must undertake. (link)
🇮🇷 Iran
While previously against the use of cryptocurrency in its country, the government of Iran appears to have had a partial change of heart and is moving ahead with a plan to introduce its own national cryptocurrency. Part of the motivation appears to be an attempt to avoid the sanctions that are being newly-imposed by the US. (link)
