As readers of our blog are aware, courts and regulators are playing catch-up when it comes to cryptocurrencies, and to interpreting existing laws and regulations as applied to these new and innovative offerings. One of these many important questions relates to whether virtual currencies are “commodities” within the meaning of the Commodity Exchange Act (CEA) and subject to regulation by the Commodity Futures Trading Commission (CFTC). A recent ruling by a US district court in Massachusetts held that a virtual currency (My Big Coin) is a commodity within the meaning of the CEA and is therefore subject to the anti-fraud authority of the CFTC, even though there currently is no futures contract on My Big Coin. My Big Coin is a Las Vegas-based creator of software that purportedly allows for the anonymous exchange of currency.
The rise of cryptocurrencies and initial coin offerings (ICOs) undoubtedly shows that we live in interesting times that regularly present us with new and innovative products, markets, and opportunities. When the words “new” and “innovative” come to mind, the federal government is usually not part of the conversation. But the US Securities and Exchange Commission (SEC) under Chairman Jay Clayton appears more than willing to challenge that stereotype and to use the SEC’s regulatory and enforcement authority to take on the complex legal and other issues arising from innovative ICOs and other cryptocurrency products. Throughout these efforts, the SEC’s message has been clear and consistent: it will apply established federal securities laws principles and use its regulatory authority over ICOs and other cryptocurrency products expansively when appropriate, and it expects “gatekeepers” to aid in that effort.
Recent SEC Enforcement Actions: Munchee and Plexcorps
Two SEC enforcement actions over the last few weeks represent just the latest attempt by the SEC to get its message across. Most recently, it announced on December 11 a settled enforcement action that halted an ICO by Munchee Inc., a California business that created an iPhone app for reviewing restaurant meals. In a remarkably quick action for the SEC, it brought the case just weeks after Munchee commenced its ICO. The SEC charged Munchee with violating Sections 5(a) and 5(c) of the Securities Act of 1933 (the Securities Act) by conducting an unregistered offering of securities, and is notable because the SEC did not allege that Munchee made any misrepresentations in connection with the offering. Bringing such a standalone unregistered offering case is unusual for the SEC and represents its intention to bring these cases quickly, even in the absence of fraud.
On July 19, the Financial Crimes Enforcement Network (FinCEN), a bureau within the US Department of the Treasury responsible for the Bank Secrecy Act, issued guidance in the form of frequently asked questions (FAQs) regarding its recently adopted customer due diligence requirements (CDD Rule). The FAQs offer a condensed summary of the CDD Rule’s requirements, but FinCEN has missed an opportunity to address an ambiguity in the CDD Rule regarding its application to private investment vehicles.
Last Friday, the US Securities and Exchange Commission (SEC) issued a notice stating that, effective in less than 70 days (July 31), broker-dealers will no longer be able to engage in leveraged foreign exchange (forex or FX) business with persons other than “eligible contract participants” as defined in Section 1a(18) of the Commodity Exchange Act (CEA), including those that are dually registered with the US Commodity Futures Trading Commission (CFTC) as Futures Commission Merchants (FCMs). What this effectively means is that only standalone CFTC registered and National Futures Association (NFA) member FCMs or retail FX dealers, as well as certain banks, may serve as counterparties in retail forex transactions.
On May 5, the Financial Crimes Enforcement Network (FinCEN) announced final rules under the Bank Secrecy Act that enhance the customer due diligence obligations of banks, broker-dealers, mutual funds, futures commission merchants, and introducing brokers in commodities (collectively, Covered Financial Institutions). The final rules will become effective 60 days after publication in the Federal Register (publication expected on May 11). The new rules, however, provide for a two-year compliance period, meaning that affected financial institutions will have until May 11, 2018 to come into full compliance.
We expect to publish a more comprehensive overview of the final rules in the coming days. In the meantime, we note that the final rules require Covered Financial Institutions to obtain beneficial ownership information of all legal entity customers (other than certain exempt accounts) for all persons who beneficially own 25% or more of the legal entity customer. Covered Financial Institutions can comply by either obtaining the required information on a standard certification form or by any other means that satisfy the requirements of the rule.
FinCEN also amended the anti-money laundering program rules applicable to Covered Financial Institutions to explicitly include risk-based procedures for conducting ongoing customer due diligence to better allow for understanding the nature and purpose of customer relationships in developing customer risk profiles.
Impact on Registered Investment Advisers
Although registered investment advisers (RIAs) are not included as Covered Financial Institutions at this time, we expect that FinCEN will soon propose rules that would apply to RIAs as part of FinCEN’s efforts to bring such entities within its regulatory umbrella. For a discussion of FinCEN’s proposed AML rules for RIAs, please see our September 2015 White Paper “AML Requirements Proposed for SEC Registered Advisers.”