In the continuation of our new blog series highlighting recent developments in the digital asset space, this post details continued action policy and enforcement actions by US regulators.
The US Securities and Exchange Commission (SEC) and US Commodity Futures Trading Commission (CFTC) brought new enforcement actions. The Federal Deposit Insurance Corporation (FDIC) announced the issuance of cease-and-desist letters to a cryptocurrency exchange, a non-bank financial institution, and two website operators. On the policy side, the SEC proposed amendments to its custody rule applicable to investment advisers in a manner that captures digital assets, the Senate Banking Committee held a hearing on the “Crypto Crash,” the CFTC established a subcommittee on Digital Assets, and a US Treasury official gave remarks on fintech and crypto.
On February 15, the SEC proposed amendments to Advisers Act Rule 206(4)-2 (the Custody Rule) that would significantly expand the scope of the current Custody Rule beyond “client funds and securities” to include all “client assets” (including “positions” held in client accounts) of which the adviser has custody. Although the SEC attempts to be “asset-neutral” in the proposal, the SEC explicitly captures digital assets. The proposed amendments would, among other things, require a qualified custodian to have “possession or control” of client assets. At least one Commissioner expressed concerns about the breadth and workability of the proposed rule, noting that compliance with this proposed requirement would be difficult for custodians of digital assets.
In addition, the proposed amendments would require an adviser to enter into a written agreement with and obtain certain “reasonable assurances” from qualified custodians in order to ensure that clients receive protections designed to properly segregate and hold client assets in accounts intended to protect such assets in the event of a qualified custodian’s bankruptcy or other insolvency. Look out for our LawFlash on this important rulemaking.
Stablecoins: On February 16, the SEC announced charges against Terraform Labs and former CEO Do Kwon alleging fraud, the offer and sale of unregistered securities, the selling of unregistered security-based swaps and other related claims. In its complaint, the SEC alleges that Terraform and Kwon defrauded investors through sales of its algorithmic stablecoin TerraUSD and “other cryptoasset securities.” The SEC’s complaint alleges that Terraform and Kwon repeatedly claimed that tokens would increase in value when marketing the tokens and, accordingly, investors expected to earn a profit when purchasing the tokens, a critical element when analyzing whether an instrument comes within the meaning of an investment contract under the eponymous Howey test. The complaint was filed in the US District Court for the Southern District of New York.
Social Media Touting: In addition, on February 17, the SEC announced that it had settled charges against former NBA player Paul Pierce for touting EMAX tokens, cryptoasset securities offered and sold by EthereumMax, on social media without disclosing the payment he received for the promotion and for making false and misleading promotional statements about the same cryptoasset. Pierce agreed to settle the charges and pay $1.409 million in penalties, disgorgement, and interest. The SEC’s order finds that Pierce violated the anti-touting and antifraud provisions of the federal securities laws.
The CFTC recently used its antimanipulation enforcement authority in an enforcement action that alleges manipulation of certain spot digital asset markets. On February 16, the CFTC announced charges against Vista Network Technologies, a California-based company, and its CEO for allegedly engaging in the fraudulent solicitation and misappropriation of customers’ digital asset commodities. The complaint alleges that the defendants engaged in a Ponzi-like scheme, using new investors’ assets to pay returns to investors who had invested earlier in the scheme while claiming that returns were the product of trading bots. The complaint was filed in the US District Court for the Eastern District of New York.
FDIC Cease-and-Desist Letters
On February 15, the FDIC sent cease and desist letters to a cryptocurrency exchange, a non-bank financial institution, and two website operators, alleging that the entities had made misleading statements to consumers by direct statement or implication: that certain assets were insured by the FDIC when they were not. The letters detail the factual allegations, explain why these allegations may amount to a violation of law, and require immediate removal of offending language. This is not the first time the FDIC has sent a cease-and-desist letter related to misleading statements regarding cryptocurrencies and FDIC insurance. The letters also are consistent with the recent proposed rulemaking on misuse of the FDIC name or logo or making misrepresentations about deposit insurance coverage (comments due April 7, 2023).
UCC Legislation Addressing Digital Assets
The 2022 Uniform Commercial Code amendments address commercial law rules for digital assets. Bills to enact the amendments, approved last year by the American Law Institute and the Uniform Law Commission, have now been filed in 21 states and the District of Columbia, with more bills expected and with the goal of uniform state enactments. Although the bills have been announced, it is unclear whether all 22 bills will be enacted into law.
CFTC Establishes Subcommittee on Digital Asset Markets
On February 13, the CFTC’s Global Markets Advisory Committee (GMAC) met to discuss, among other things, the state of digital assets markets. The GMAC voted to establish a digital asset markets subcommittee and discussed (1) international policy and regulation and (2) digital finance, tokenization, Web3, blockchain technology, and other use cases. Representatives who attended the GMAC meeting to provide insight on the digital assets market included various trades association and market participants.
US Treasury Remarks on Crypto
On February 15, Assistant Secretary for Financial Institutions Graham Steele delivered remarks on fintech and crypto before the Exchequer Club of Washington, DC. In his speech, Steele focused on the systemic risks of crypto, agreeing with the banking agencies’ joint statement that “issuing or holding as principal crypto assets that are issued, stored, or transferred on an open, public, or decentralized network is highly likely to be to be inconsistent with safe and sound banking.”
Senate Banking Hearing
On February 14, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled “Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets.” Chairman Brown’s opening statement spelled out in detail the challenges that the digital assets industry experienced this year but also laid out a basic formula that he will use to approach legislation, which would include disclosure, prohibitions on conflicts of interest and self-dealing by insiders, protecting customer funds, and anti-money laundering and fraud prevention, among other things.
Support for legislation creating a basic regulatory footprint seems bipartisan at this point, although it’s important to keep in mind that the devil is always in the details. Senator Tom Tillis (R-NC) asked witnesses about proof of reserves, while other members and witnesses discussed segregation of assets and other protections, such as Know-Your-Customer (KYC) and anti-money laundering requirements. While the search for common ground currently is bipartisan, distrust of the recent SEC actions has been bicameral. Ranking Member Tim Scott (R-SC) noted in his opening statement that Chairman Gensler “had lots of time to do the rounds on the morning talk shows” and if he has time for the talk shows, “he should be here testifying with us.”
Meanwhile, House Financial Service Committee Chairman Patrick McHenry tweeted about the SEC’s proposed amendments to the Custody Rule, calling them an “attack on the digital asset ecosystem.” He also stated, “Congress delegates authority to the SEC, not the other way around.” It is unclear whether this anti-Gensler sentiment will translate into legislation disavowing SEC actions in the digital asset space.
UK Jurisdiction Taskforce Statement on Digital Securities
The UK Jurisdiction Taskforce of LawtechUK published on February 9 a legal statement of its view as to whether English private law can support the issue and transfer of debt or equity and other contractual securities using a system that deploys blockchain or distributed ledger technology (DLT). It concludes that the existing English law framework supports the issue and transfer of securities on blockchain or DLT-based systems and highlights the benefits of English law’s inherent flexibility. However, it considers, among other things, that while there is in principle no difficulty in the United Kingdom or foreign companies issuing English law-governed digital securities using a blockchain or DLT-based system, the need to comply with the UK Companies Act 2006 requirements for share transfers and registration does present challenges for digital equity securities of UK companies.
Law clerk Erin Engelmenn contributed to this blog post.