Regulatory and Compliance Updates — June 1 — June 15
Updates on regulatory and compliance issues in the blockchain and cryptocurrency industry for the period from June 1 — June 15 are below. We hope these updates help our community stay informed.
🇺🇸 United States
SEC — A New Czar and a (Potentially) Important Announcement
On June 4, the U.S. Securities and Exchange Commission (“SEC”) appointed its first “Crypto Czar”, long-time SEC veteran Valerie Szczepanik, who will oversee the agency’s cryptocurrency and ICO regulation. In her initial statements, the new Czar said that the SEC is interested in working collaboratively with entrepreneurs and suggested that regulatory compliance could be built into tokens via smart contracts. Szczepanik indicated that the SEC would release additional guidance about ICOs but did not say when that would happen. (link)
Other SEC officials also made statements about cryptocurrency over the past couple of weeks, with the director of the Division of Trading and Markets criticizing cryptocurrency exchanges for being unenthusiastic about registering with the SEC (link) and Commissioner Jay Clayton reiterating his view that all ICO tokens he has seen are securities. However, Commissioner Clayton also said that cryptocurrencies that serve as a replacement for sovereign currencies, such as bitcoin, are not securities (link).
Of course, the most notable statement from the SEC in the first half of this month came in the June 14th speech from director of Corporate Finance William Hinman, in which he expressed the view that Ethereum “in its current state” is not a security. The key reasoning behind Hinman’s argument is that if a network on which a token functions is “sufficiently decentralized,” then “purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts”, knocking out one of the main prongs of the famous Howey test. As a result, “the assets may not represent an investment contract.” Hinman’s speech emphasizes this point of decentralization, noting that if a network is “truly decentralized”, it will be difficult to identify a person to make the disclosures required under the securities laws.
This announcement has been enthusiastically embraced by the crypto community at large. While this is definitely a helpful statement, there are a few reasons not get carried away in relying on this view, particularly for developers of other projects. First, as the footnotes to the text of the speech published on the SEC website make clear, the “speech expresses the author’s views and does not necessarily reflect those of the [SEC].” Second, the statement is not necessarily as ground-breaking as it has been made out to be, although the specific application to Ethereum is new. Hinman himself expressed a similar view in front of Congress back in April and even Commissioner Clayton (who has generally been perceived as less friendly to ICOs) has previously indicated that there might be a sliding scale of security-ness that may change over the life of a token.
In addition, other parts of the speech are less happy for token issuers — specifically, Hinman’s analysis is qualified in that it only relates to Ethereum now and leaves open the question as to whether Ethereum was a security when it was first marketed and sold. Nothing in the statement indicates that the SEC will not go after the fundraising activities of projects that have not yet reached the level of decentralization that Ethereum has achieved. This leaves open the question as to whether, now that the SEC is paying more attention than it was in 2014, any other digital token will be given the leeway to sell tokens and develop its platform to the point that it achieves the requisite level of decentralization (whatever that turns out to be, the speech does not set out any real standard). Furthermore, it should be noted that even if the SEC does adopt Hinman’s view, courts could take a different approach, especially if the ICO for Ethereum is ever challenged in court by purchasers who participated.
The speech covers a lot of important ground, including setting out a variety of factors that Hinman believes the SEC should consider in making these determinations and giving a list of questions that ICO issuers and their advisors should consider when designing technical features of their tokens.
The CFTC’s Price Manipulation Probe
In another important development, on June 8 the Wall Street Journal reported that the Commodity Futures Trading Commission (“CFTC”) subpoenaed several cryptocurrency exchanges in its ongoing investigation of alleged manipulation of bitcoin prices, which in turn manipulated the prices of derivatives based on bitcoin. The probe is examining whether traders on four crypto exchanges used trading practices such as “spoofing” to impact the price of derivatives that are based on bitcoin, such as the bitcoin futures contracts traded with the CME Group, a large derivatives exchange. The CFTC’s subpoenas demanded that the exchanges provide it with comprehensive trade data. This is consistent with the CFTC’s approach in the guidance it released last month, in which it emphasized the need for derivatives exchanges and the CFTC itself to have access to underlying trade data from cryptocurrency spot markets. According to the Wall Street journal report, the CFTC investigation was sparked when the cryptocurrency exchanges refused to share comprehensive trading data with the CME Group, inspiring the CFTC to step in to investigate. (link)
Meanwhile, the agency was less forthcoming with its own information,denying a Freedom of Information Act request asking to view subpoenas related to the case, citing its ongoing probe.
State Law
Various states continued their efforts to regulate the crypto/blockchain space. Vermont’s regulators halted an ICO in their state with a cease-and desist notice. While the issuer did make some representations that it was excluding US residents and was only offering securities to “accredited investors,” it appears that these restrictions were not strictly applied and did not help the issuer avoid regulatory scrutiny. New York approved Stellar’s Lumens tokens to trade on the ItBit exchange (which is one of the only exchanges that holds New York’s Bitlicense and previously only traded bitcoin).
Connecticut’s legislature passed a bill to create a blockchain working group and Michigan proposed a law making it illegal to forge or counterfeit blockchain data. It is somewhat unclear how the latter law is supposed to work or what it would apply to. Los Angeles police arrested a bitcoin trader for running an illegal money exchange business.
International Organizations
The Financial Action Task Force (“FATF”), the key international organization that sets standards for countries to follow in the area of Anti-Money Laundering and Counter Finance of Terrorism (“AML/CTF”) regulations announced that it is planning to come out with standards that will be required for all countries. Previously, FATF has only released non-binding “recommendations” related to virtual currency. While not technically binding law, failure to follow FATF standards can lead to countries having difficulty participating in the international economy. (Link)
🇨🇦 Canada
Canada’s anti-money laundering agency came out with a draft of new regulations on June 9th that would, if adopted, impose various reporting and other requirements on financial entities and money services business whose activities include “dealing in” virtual currencies, including both exchange and value transfer services. Among the regulations, regulated entities would be required to file reports whenever they receive or transfer amounts of virtual currencies above a certain threshold, would need to comply with various record-keeping requirements with respect to virtual currency transactions and would have to verify customer identities when processing such transactions. (link)
The Canadian Securities Authority also released new guidance on ICOs. The guidance discusses when a token will be considered a utility token, includes various examples of ICOs and discusses multi-step approaches like the SAFT. Interestingly, the CSA notes that a multi-step process may actually make it more likely for the agency to view such approaches with suspicion. (link)
In more local Canadian news, the province of Quebec halted approvals of cryptocurrency mining out of electricity-related concerns. (link)
🇯🇵 Japan
While Japan is generally far ahead of other countries in creating a space where cryptocurrency exchanges can operate with regulatory approval, this month’s news shows that this should not be taken to mean that the approach there is always uniformly lenient. The Financial Services Agency denied its first application from an exchange to register with the agency, in part due to failures to comply with financial rules before the application. In addition, Japanese prosecutors arrested 16 individuals for installing malware on victim’s computers that was used to mine cryptocurrencies.
🇬🇧 United Kingdom
The UK’s Financial Conduct Authority released guidance telling banks how to handle risks associated with crypto assets. Among the recommendations, the banks suggest engaging with clients engaged in crypto assets to determine the nature of their business and the risks posed, carrying out due diligence on key individuals in the client business, assessing the client’s own due diligence procedures and considering ICO token functionality. (link)
🇷🇺 Russia
During the course of an appeal, a Russian city court overturned a ruling by a lower court that ultimately led to the blocking of approximately 100 cryptocurrency websites on the theory that providing information on cryptocurrency could undermine the nation’s currency. Under the new ruling, the websites should be accessible in Russia. (link)
🇱🇹 Lithuania
Lithuania released guidelines on June 8 that set forth when ICO tokens are considered securities — generally, when they grant profits or governance rights and have characteristics of a security. Other tokens will be governed under various other laws, including laws governing financial instruments, crowdfunding laws and collective investment laws. All tokens are subject to AML/CFT laws, which are also discussed in the guidelines. The guidelines also explain tax and accounting issues under local laws. (link)
🇳🇱 Netherlands
The Dutch financial regulator released a letter on June 13 raising doubts about whether cryptocurrency businesses in the country are properly following licensing laws. In addition to questioning the risks involved, the regulator also questioned whether such businesses are even capable of meeting all necessary requirements to be licensed. (link)
🇵🇱 Poland
While it has recently engaged in a social media campaign to warn investors against cryptocurrencies, the Polish financial regulatory made an official announcement on June 6 qualifying that there are no regulations prohibiting trading in cryptocurrencies. (link)
🇰🇷 South Korea
On June 8, a South Korean government investigation cleared the Bithumb exchange (the largest in South Korea and7th largest in the world) from any wrongdoing. The original investigation was prompted by the exchange reporting massive 171-fold increases in profits over a 12-month period. (link)
South Korean police may bring charges against the Coinone exchange over its provision of margin trading, which the police allege is a form of illegal gambling. (link)
🇻🇳 Vietnam
Vietnam’s finance ministry proposed a temporary ban on importing mining hardware. (link)
🇨🇴 Colombia
In another chapter of the international struggle of crypto and blockchain companies to open bank accounts, a group of banks in Colombia teamed up to close the bank accounts of the Buda.com cryptocurrency exchange. Local media reported that the reason for the bank’s actions was an internal letter from Colombian regulators reminding the banks that they are not authorized to interact with cryptocurrency platforms. (link)
Market Regulation — Apple and Wells Fargo
In addition to looking at laws promulgated by governments, Lawrence Lessig’s famous “pathetic dot theory” notes that markets can also provide a form of regulation that constrains individual actions. While these updates focus more on the classic governmental form of regulation, it is worth noting that Apple came out with new terms of service that address whether cryptocurrency-related apps will be allowed in its app store. Under the new rules, cryptocurrency mining apps are forbidden, wallets are permitted, apps that facilitate exchanges are allowed as long as they are offered by the exchange itself and apps facilitating ICOs are permitted as long as they come from established financial institutions and comply with all applicable law. None of these apps are permitted to offer cryptocurrency as a reward for completing tasks in the app. (link)
Wells Fargo made a decision to stop allowing its credit cards to be used to purchase bitcoin and other cryptocurrencies. JP Morgan, Citi and Bank of America all previously made similar rules, making it more difficult for US customers to purchase cryptocurrency. (link)
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This update has been prepared by the Orbs Ltd. legal team for informational purposes only and does not constitute advertising or solicitation and should not be used or taken as legal advice. Those seeking legal advice should contact legal counsel licensed in their jurisdiction. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. Confidential information should not be sent to Orbs Ltd. in response to this update.
