U.S. Developments

Hester Peirce Remarks at Cato Institute Conference

Hester Peirce made remarks at the Cato Institute’s Fintech Unbound conference on September 12, 2018. Commissioner Peirce commented that securities regulators are too risk averse, stating that “capital markets are all about taking risk, and queasiness around risk-taking is particularly inapt” and that “a key purpose of financial markets is to permit investors to take risks, commensurate with their own risk appetites and circumstances, to earn returns on their investments.”

Peirce expressed particular concern with the SEC’s recent decision to deny an exchange’s bid to list shares of the Winklevoss Bitcoin Trust, stating that she was troubled by the Commission’s order, which provided an assessment of the underlying asset, rather than on whether the exchange had taken steps to ensure the orderly trading of shares. She emphasized that she and the Commission do not have the capacity to assess cryptocurrency marketplace success and cautioned that the SEC risks implying that they are competent to make such assessments.

Peirce then proceeded to provide five lessons for the SEC, which she hopes will serve to make regulators “more nimble in dealing with fintech innovations that are intended to create more opportunities for investors to gain exposure to our markets.” Peirce’s first lesson asked regulators to approach innovation with humility because of the challenges involved in judging the risks and benefits of new technologies, stating that the SEC should “resist the temptation to treat uncertainty as a disqualifier.” Second, she encouraged the SEC to create space for innovation or risk investors seeking out innovation in unregulated spaces. Third, she offered that innovators should have “greater clarity and certainty in their interactions with the Commission and its staff.” Fourth, Peirce stated that the SEC should expand investor access to financial markets, particularly through innovative technologies. Fifth, Peirce warned that if regulators do not “become more comfortable with risk, our helicoptering may so burden fintech innovations that they begin to lumber along at a regulatory pace.”

Find Peirce’s full remarks here. 

New York Attorney General Releases Virtual Markets Integrity Initiative Report 

On September 18, 2018, the New York Attorney General, Barbara D. Underwood, released a report on their Virtual Markets and Integrity Initiative findings. The New York State Office of the Attorney General (OAG) launched the Virtual Markets and Integrity Initiative in April of 2018 as a “fact-finding inquiry into the policies and practices of virtual asset trading platforms.” The OAG sought voluntary participation of major trading platforms that are operational in New York, with a total of 10 trading platforms participating. The OAG’s key findings are as follows:

• “Virtual asset trading platforms often engage in several lines of business that would be restricted or carefully monitored in a traditional trading environment. Platforms often serve (i) as venues of exchange, operating the platform on which buyers and sellers trade virtual and fiat currencies; (ii) in a role akin to a traditional broker-dealer, representing traders and executing trades on their behalf; (iii) as money-transmitters, transferring virtual and fiat currency and converting it from one form to another; (iv) as proprietary traders, buying and selling virtual currency for their own accounts, often on their own platforms; (v) as owners of large virtual currency holdings; and, in some cases, (vi) as issuers of a virtual currency listed on their own and other platforms, with a direct stake in its performance. Additionally, platform employees – who may have access to information about customer orders, new currency listings, and other nonpublic information – often hold virtual currency and trade on their own or competing platforms. Each role has a markedly different set of incentives, introducing substantial potential for conflicts between the interests of the platform, platform insiders, and platform customers.”

• “Though some virtual currency platforms have taken steps to police the fairness of their platforms and safeguard the integrity of their exchange, others have not. Platforms lack robust real-time and historical market surveillance capabilities, like those found in traditional trading venues, to identify and stop suspicious trading patterns. There is no mechanism for analyzing suspicious trading strategies across multiple platforms. Few platforms seriously restrict or even monitor the operation of “bots” or automated algorithmic trading on their venues. Indeed, certain trading platforms deny any responsibility for stopping traders from artificially affecting prices. Those factors, coupled with the concentration of virtual currency in the hands of a relatively small number of major traders, leave the platforms highly susceptible to abuse. Only a small number of platforms have taken meaningful steps to lessen those risks.”

• “Generally accepted methods for auditing virtual assets do not exist, and trading platforms lack a consistent and transparent approach to independently auditing the virtual currency purportedly in their possession; several do not claim to do any independent auditing of their virtual currency holdings at all. That makes it difficult or impossible to confirm whether platforms are responsibly holding their customers’ virtual assets as claimed. Customers are highly exposed in the event of a hack or unauthorized withdrawal. While domestic or foreign deposit insurance may compensate customers Page 6 for certain losses of stolen or misappropriated fiat currency, no similar compensation is available for virtual currency losses. There are serious questions about the scope and sufficiency of the commercial insurance that certain platforms purport to carry to cover virtual asset losses. Other platforms do not insure against virtual asset losses at all.”

The OAG press release is found here. 

FDIC Seeks Comment on Reciprocal Deposit Treatment

The Federal Deposit Insurance Corporation (FDIC) has requested public comment on its proposed rule regarding the treatment of reciprocal deposits. This proposed rule seeks to conform the FDIC’s current regulations with recent changes to the Federal Deposit Insurance Act (FDI Act) that, for certain insured depository institutions, excepts a capped amount of reciprocal brokered deposits from treatment as brokered deposits. The FDIC’s proposed rule incorporates the statutory definitions from the most recent amendment to the FDI Act directly into the regulations.

Reciprocal deposit arrangements are formed when banks create a network to place funds at other participating banks, allowing depositors to receive insurance coverage for their full deposit amount. Given the complexity involved, third parties often manage and facilitate this process, which results in the characterization of this transaction as a brokered deposit. Under the proposed rule “well capitalized” and “well rated” institutions are exempted from treating reciprocal deposits as brokered deposits up to the lesser of 20 percent of its total liabilities or $5 billion; furthermore, institutions that do not meet the well capitalized and well rated standards may also qualify for the exclusion under certain circumstances.

This proposed rule is the first of a two-part effort to revisit the brokered deposit rules. The second part, expected later this year, will seek more general comments on the brokered deposit regulations.

The FDIC’s press release can be found here.

US Lawmakers Urge the IRS to Provide Crypto Tax Guidance

A group of lawmakers, including Kevin Brady, David Schweikert, Brad Wenstrup, Lynn Jenkins, and Darin LaHood wrote a letter to IRS Commissioner David Kautter urging the IRS to provide guidance on taxpayer obligations when using virtual currencies. In 2014, the IRS provided preliminary guidance on the tax treatment of virtual currencies in Notice 2014-21. The IRS has not issued any additional guidance since that time. In their letter, the lawmakers criticized the IRS for prioritizing enforcement actions while not providing sufficient guidance on how taxpayers may meet their tax obligations when using virtual currencies. The lawmakers urged the IRS to update their guidance in an expedited manner.

The letter may be found here.

Texas State Securities Board Issues Cease and Desist Orders Against Cryptocurrency Investment Schemes

Texas Securities Commissioner Travis J. Iles entered emergency cease and desist orders against Coins Miner Investment Ltd., DGBK Ltd., and Ultimate Assets LLC,. According to the cease and desist order brought against Coins Miner, Coins Miner is “an issuer of investments in cryptocurrency mining programs that publicly claims to be operating in the United Kingdom. In truth and in fact, it is actually operating in Russia.” The cease and desist order goes on to describe Coins Miner as falsely adding legitimacy to its cryptocurrency mining program by spoofing an email address and using fake photographs and videos. The emergency cease and desist order brought against DGKB, also known as DigitalBank, stated that DigitalBank claimed to be developing an unhackable wallet. The investigation into DigitalBank alleges to have uncovered evidence of fraud in connection with the offer of securities. Lastly, the cease and desist order brought again Ultimate Assets alleges that the company “published advertisements in cryptocurrency and Forex trading programs,” which told potential investors that “returns are always guaranteed” and involve “no risk.”

International Developments

The Monetary Authority of Singapore Releases Fraud Warning 

The Monetary Authority of Singapore (MAS) released a warning that a “fraudulent website has been soliciting investments in Bitcoins using fabricated comments attributed to the MAS Chairman and Deputy Prime Minister, Tharman Shanmugaratnam.” The warning provides that the website asks readers to sign up for a Bitcoin account, requesting credit card and bank account information. While the warning does not include the web address, screenshots of the website are provided with the warning.

The warning is found here. 

UK Lawmakers Call for Crypto Asset Regulation 

On September 19, the UK Parliament’s Treasury Committee issued a report in which they recommended regulation of the crypto-asset market. The report concluded that “Crypto-assets have no inherent value,” and that their volatility poses risks for inexperienced investors. The Committee found that self-regulating bodies within the crypto industry are insufficient to protect investors, concluding that the Financial Conduct Authority should serve as the lead regulatory body to, at a minimum, addresses consumer protections and anti-money laundering concerns.

The full report can be found here.

Brazil Antitrust Investigation

Reuters has reported that a Brazilian antitrust watchdog group, CADE, has opened an investigation into some of the country’s largest banks for allegedly closing accounts belonging to brokerages trading in bitcoin. CADE will investigate whether banks are restricting or prohibiting cryptocurrency brokerages from accessing financial systems. The banks, on the other hand, argue that they closed these accounts because of money laundering concerns.

The Reuters article is found here.

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