The International Organization of Securities Commissions articulated considerations for worldwide regulators evaluating cryptoasset trading platforms within their regulatory perimeter. However, IOSCO noted this assessment poses unique challenges because while CTPs share many common characteristics of trading platforms, they also often perform functions associated with intermediaries, custodians, transfer agents and/or clearinghouses. Separately, two food giants and the Commodity Futures Trading Commission appear poised once again to resolve the CFTC’s 2015 enforcement action charging the defendants with manipulation; a prior settlement was set aside by the presiding judge. However, contempt findings may still be imposed against the CFTC for its conduct in connection with the original settlement although the defendants may no longer be requesting such an outcome. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- IOSCO Suggests Key Considerations for International Regulators With Oversight Over Cryptoasset Trading Platforms (includes My View);
- Food Groups and CFTC DOE Again Poised to Settle 2015 Enforcement Action; Potential Contempt Finding Against Commission Hovering (includes My View); and more.
Please click here for the Video Version.
- IOSCO Suggests Key Considerations for International Regulators With Oversight Over Cryptoasset Trading Platforms: The International Organization of Securities Commissions issued a report enumerating issues and risks associated with cryptoasset trading platforms (“CTPs”), and key considerations regulators may apply in evaluating CTPs within their regulatory perimeter.
Generally, IOSCO’s identified considerations addressed access to CTPs; protecting customer assets; identifying and managing conflicts of interest; transparency of CTPs’ operations; market integrity including rules governing trading and how compliance with such rules are monitored and enforced; effectiveness of price discovery (pre- and post-trade transparency); and ensuring the resilience and cyber security of technology.
For purpose of its report, IOSCO defined a CTP as “a facility or system that brings together buyers and sellers of cryptoassets for the purpose of completing transactions or trades” while a cryptoasset is a type of “private asset that depends primarily on cryptography and [distributed ledger] or similar technology as part of its perceived, or inherent value” and could represent an asset or ownership of an asset including a currency, commodity, security, or a derivative on a security or a commodity.
IOSCO noted that CTPs are, in many respects, similar to trading venues, but may also perform functions typically undertaken by intermediaries, custodians, transfer agents and/or clearinghouses.
In articulating considerations, IOSCO made clear it was not mandating a specific regulatory outcome. Rather, it was proposing “specific areas that IOSCO believes jurisdictions could consider in the context of the regulation of CTPs” (emphasis added).
In evaluating access to CTPs, IOSCO recommended that regulators consider how access is provided, including who is responsible for on-boarding and how is it effectuated. IOSCO noted that CTPs differ widely in their admission standards in that some limit access to regulated intermediaries while others permit non-intermediated access to institutions and/or retail persons. Where retail persons are permitted, said IOSCO, “consideration of whether CTPs are undertaking any investor suitability assessments prior to account opening is important.” Evaluation of risk disclosures provided to retail investors is also significant.
For all non-intermediated customers, said IOSCO, the availability and nature of disclosures regarding a CTP’s operations, including rules related to fair and orderly trading and investor protection, is something regulators should weigh.
IOSCO also indicated that regulators should assess how participant assets are held and protected. This would include understanding what is supposed to happen when there might be a loss, including a loss due to the bankruptcy of a CTP or theft. IOSCO said that, because trading venues do not ordinarily custody assets, it is important for regulators to consider the risks of operational failure for relevant CTPs; theft or loss of, or inability to access, private keys; commingling of assets; faulty recordkeeping; and insufficient assets to meet customers’ claims. Consideration of these issues requires evaluation of what protections, if any, a CTP has implemented to compensate investors if there is a loss and whether a CTP has adequate financial resources to fund an orderly wind-down if the CTP must terminate operations because of insolvency or otherwise.
IOSCO said that regulators should also evaluate what conflicts of interest exist because of a CTP’s structure and organization, and how they are disclosed, managed and mitigated. Regulators should also consider how a CTP ensures the resiliency and integrity of its critical systems.
Notwithstanding its general caveat that it was not making specific recommendations in its report, IOSCO said that, where a cryptoasset is a security and falls within a regulator’s remit, “the basic principles of securities regulation should apply.” IOSCO noted however, that it was not, at this time, providing a roadmap for regulators to assess whether a cryptoasset falls within its regulatory remit.
As part of its report, IOSCO included information provided by a number of international regulators related to their existing regulatory framework pertaining to CTPs.
IOSCO is an international organization comprising most of the world’s principal securities and derivatives conduct regulators. It develops, implements and promotes international standards for securities and derivatives regulation. (Click here for background.) IOSCO initially sought feedback on its report in May 2019. (Click here for background in the article "IOSCO Solicits Feedback on Proposed Key Considerations for Regulators' Evaluation of Cryptoasset Trading Platforms" in the June 9, 2019 edition of Bridging the Week.)
In other legal and regulatory developments regarding cryptoassets:
- CFTC DSIO Director Issues Statement Offering Assistance to Pooled Vehicles and Asset Managers Trading Derivatives on Virtual Currencies: Joshua Sterling, Director of the Division of Swap Dealer and Intermediary Oversight at the Commodity Futures Trading Commission, issued a statement inviting commodity pool operators and other asset managers considering to offer pooled investment vehicles that might trade commodity interests (e.g., swaps and futures) that reference digital assets (e.g., bitcoin and stablecoins) to meet with DSIO staff to discuss their product ideas. He said staff “can serve as a ready guide on key issues and considerations.” Mr. Sterling claimed that his offer of outreach is motivated by DSIO’s support of “responsible innovation” and a desire “to help market participants ensure that these innovations can develop in a practical way that is consistent with the law.”
- DOJ, CFTC and SEC File Coordinated Legal Actions Against Purported Digital Asset Scam Aimed at Physicians: Michael Ackerman was named in separate enforcement actions filed on February 11 by the Securities and Exchange Commission and the CFTC for an investment scheme involving virtual currencies he purportedly organized and promoted aimed principally at physicians. Both agencies charged Mr. Ackerman with misleading investors regarding the performance of his trading and his use and the safety of invested funds. On the same date, the US Department of Justice disclosed the unsealing of a criminal indictment charging Mr. Ackerman with wire fraud and money laundering in connection with same activities. The CFTC enforcement action also named Q3 Holdings , LLC and Q3 1, LP (collectively, “Q3”), non-registered trading entities used by Mr. Ackerman for trading that the CFTC charged Mr. Ackerman controlled. All three legal actions were filed in a federal court in New York.
Although the precise factual and legal allegations in each agency's complaint were somewhat different, according to the SEC and CFTC, from at least August 2017 through December 2019, Mr. Ackerman and Q3 raised more than US $33 million from over 150 individuals. In excess of US $25 million was transferred to personal bank accounts of Mr. Ackerman and two other persons who founded Q3; Mr. Ackerman himself retained US $7 million of these funds. The two regulators charged that, to entice potential customers to invest with Q3, the defendants falsely and materially inflated the profitability of their trading and provided customers with false accounting statements and other documents with fake performance results. The SEC additionally charged that Mr. Ackerman falsely represented he could not access customer funds without the authorization of a second partner. In some instances, when investors requested redemptions, defendants used funds of other customers to pay such investors, said the CFTC.
The SEC and CFTC seek an injunction, disgorgement and a fine against Mr. Ackerman.
My View: On February 6, the CFTC was invited by the Hon. P. Kevin Castel to “express its views” on issues currently being considered by a US federal court in New York in connection with the SEC’s enforcement action against Telegraph Group Inc. and Ton Issuer Inc.; The Hon. Judge Castel is presiding over this matter in a US federal court in New York City. (Click here for a copy of the relevant court order.)
In November 2019, the SEC charged that defendants’ offering and sale of “Gram” cryptoassets during the first quarter of 2018 constituted a securities offering that was not appropriately registered, while defendants claimed their first quarter activities constituted the lawful offer and sale of an investment contract that was validly exempt from registration and that contemplated the ultimate delivery of cryptoassets when (and if) the relevant blockchain was functional which digital assets would constitute virtual currencies and not securities. (Click here for background in the article “Security or Virtual Currency?: Online Messaging Company and SEC File Competing Motions to Resolve ICO Enforcement Action Based on Different View of Same Cryptoasset” in the January 19, 2020 edition of Bridging the Week.)
Although it is doubtful the CFTC in any court filing would volunteer that “Gram” cryptoassets would have been virtual currencies when generally made available to the public as argued by the defendants, it likely will acknowledge that virtual currencies are commodities as defined under relevant law. (Click here for background in the article “Second Federal Court Rules That Cryptocurrencies Are Commodities and CFTC Has Anti-Fraud Jurisdiction Over Alleged Wrongdoing” in the September 30, 2018 edition of Bridging the Week.)
Additionally, the CFTC is likely to note (as it has done previously) that its jurisdiction is “implicated” when (1) a derivatives contract is based on a virtual currency; (2) there is fraud or manipulation in connection with a virtual currency traded in interstate commerce; or (3) there are transactions involving a virtual currency with retail persons (specifically, non-eligible contract participants) that involve margin, leverage or financing and no actual delivery occurs within 28 days. (For background, click here to access the article “ CFTC Issues ABC’s on Virtual Currencies – Actually the Bitcoin, Ether and Ripple” in the October 22, 2017 edition of Bridging the Week. Click here to also see the article “CFTC Proposes Interpretation to Make Clear: Retail Client + Virtual Currency Transaction + Financing + No Actual Delivery by 28 Days + No Registration = Trouble” in the December 17, 2017 edition of Bridging the Week.)
Unfortunately, the CFTC will likely not articulate a bright line test specifying when a cryptoasset is a security or a virtual currency. Indeed, when LabCFTC discussed the SEC’s 21(a) order regarding the DAO and initial coin offerings in a primer on virtual currencies published in October 2017, it punted the issue when it obliquely stated:
There is no inconsistency between the SEC’s analysis and the CFTC’s determination that virtual currencies are commodities and that virtual tokens may be commodities or derivatives contracts depending on the particular facts and circumstances. The CFTC looks beyond form and considers the actual substance and purpose of an activity when applying the federal commodities laws and CFTC regulations.
In its primer, LabCFTC discussed characteristics of virtual currencies, but did not enumerate what substance and purpose of activities involving a digital asset might bring it within its regulatory perimeter as opposed to the SEC's – in particular, what standards the CFTC might apply in evaluating a designated contract market's or swap execution facility's application or self-certification to list a derivatives contract based on a virtual currency other than bitcoin. (Click here to access A CFTC Primer on Virtual Currencies by LabCFTC. Click here to access the DAO order and here for background on the CFTC's approval process for new derivatives contracts in the CFTC's December 2017 Backgrounder on Self-Certified Contracts for Bitcoin Products.)
In December 2018, the CFTC appeared poised to advance its thinking on this topic when it publicly sought comment on the virtual currency ether – a cryptoasset that likely was once a security but is no longer. However, there has been no public follow-up on that Request for Information. (Click here for background in the article “CFTC Seeks to Fuel Up Its Knowledge of Ether” in the December 16, 2018 edition of Bridging the Week.)
The CFTC now has another opportunity to provide insight as to what specific qualities distinguish a virtual currency from a security digital token. Again, I don’t think the Commission will use this opportunity to do so. However, the Commission’s particular views on this subject would likely be very meaningful to the Hon. Judge Castel and very helpful to the entire cryptoasset industry.
That being said, in her recent proposal for a safe harbor for initial coin offerings, SEC Commissioner Hester Peirce effectively offered some characteristics of a digital asset that could potentially cause it to be considered a commodity subject to CFTC and not SEC jurisdiction:
1. it cannot represent a financial interest in a company, partnership or fund, including an ownership or debt instrument. It cannot provide entitlement to any revenue, interest or dividend payment; and
2. the network on which the token operates is:
a. not controlled or likely to be controlled or unilaterally altered by any single person or group of persons or entities acting in concert; or
b. functional as evidenced by holders’ ability to use tokens
- for the transmission and storage of value;
- to demonstrate control over the tokens;
- to participate in a network-running application; or
- in a way consistent with the network’s utility.
These elements provide a very good foundation for an important discussion that hopefully soon leads to a bright line test. (Click here for background in the article “SEC Crypto Mom Cooks Up Tasty Three-Year Safe Harbor Proposal for New Digital Token Sales” in the February 9, 2019 edition of Bridging the Week.)
- Food Groups and CFTC DOE Again Poised to Settle 2015 Enforcement Action; Potential Contempt Finding Against Commission Hovering: Kraft Foods Group, Inc. and Mondelez Global, LLC apparently agreed for a second time to terms of a settlement with the Division of Enforcement of the Commodity Futures Trading Commission arising from the CFTC’s 2015 enforcement action charging the two companies with manipulating and attempting to manipulate December 2011 wheat futures contracts and cash wheat.
No terms of the settlement were announced, but, in a docket entry made by the Hon. Robert Blakey on February 14, the presiding judge stayed all pending court proceedings and referenced “ongoing settlement negotiations.” The Hon. Judge Blakey also partly granted defendants’ August 16, 2019 motion for contempt, sanctions and other relief against the CFTC, and indicated he will issue findings of fact and conclusions of law by separate order. (Click here to access the relevant August 2019 docket entries.)
In August 2019, the defendants agreed to remit US $16 million to the CFTC to resolve the enforcement action. The consent order reflecting the settlement – unlike other typical CFTC consent orders – did not contain any factual findings or conclusions of law.
In their settlement, the CFTC and the defendants agreed not to make any public statements about the case other than referencing the settlement agreement between the parties and public documents filed in the enforcement action. However, concurrently with its announcement of the settlement, the CFTC issued a press release summarizing its complaint against the defendants including a statement that “[t]he $16 million penalty is approximately three times defendants’ alleged gain” and a comment by then new Chairman Heath Tarbert regarding the harm of market manipulation to farmers. The CFTC also released a “Statement of the Commission” and a joint statement by Commissioners Dan Berkovitz and Rostin Behnam. (Click here for background regarding the settlement in the article “Mum’s the Word – Maybe: CFTC Officially Agrees to Keep Quiet About Settlement of Manipulation Complaint That Nets US $16 Million Penalty; Unofficially?” in the August 18, 2019 edition of Bridging the Week.)
After a tortious motion practice journey that included a stop at the Court of Appeals for the Seventh Circuit and threats of criminal contempt against the CFTC, the Hon. Judge Blakey formally set aside the settlement in October 23, 2019. The parties resumed motion and discovery processes related to this matter since then. (Click here for background in the article “District Court Judge Calls for Do Over in Settlement of CFTC Enforcement Action Against Food Giants After Court of Appeals Mostly Grants Commission’s Mandamus Request” in the November 3, 2019 edition of Bridging the Week.)
My View: According to at least one news article, defendants agreed to withdraw their motion for contempt as part of their proposed settlement with the CFTC during a conference on February 13. (Click here to access the article “Deja vu all over again: CFTC and Kraft tell judge they have agreed to settle” by Brad Rosen in the February 13, 2020 edition of Securities and Regulation Daily.) However, it appears that, notwithstanding, Judge Blakey insists on having the last word on this matter, terming the CFTC’s initial handling of the original settlement “egregious misconduct.”
This is another very odd twist in a settlement process that is already full of an extraordinary number of unusual turns.
- NFA Identifies Regulatory Deficiencies Often Identified During Examinations of Members: The National Futures Association issued three Notices to Members identifying regulatory obligations commonly identified as deficiencies during members’ examinations. In enumerating the deficiencies, however, NFA provided no color on how members are potentially violating the regulatory requirements.
For all members, the most common deficiencies related to their duty of supervision and obligation to comply with certain cybersecurity requirements.
For futures commission merchants and introducing brokers, the most frequent deficiencies also included their obligation to complete a form of self-examination questionnaire at least yearly and comply with anti-money laundering program requirements. Swap dealers additionally had breakdowns related to compliance with business conduct standards and swap data reporting. Among the standards most at issue were the obligation of SDs to (1) acquire and keep a record of essential facts in order to correctly categorize counterparties (e.g., pre-trade mid-market marks); (2) make certain required disclosures; and (3) implement controls to prevent various abusive practices including fraud and manipulation. Commodity pool operators also had issues regarding required notifications (e.g., filing notice with NFA within 90 days after a pool’s formation if a CPO wishes to have a fiscal year end other than a calendar year end) and calculation of financial ratios.
- Trans-European Financial Regulator Urges Disclosure Standards Uniformity for Financial Services Firms Touting ESG: Steven Maijoor, Chair of the European Securities and Markets Authority, noted in a speech on February 12 that the measurement, verification and disclosure of ESG factors by financial market participants and companies are critical for investors to assess the risks, returns and value of their investments. These measures, he said, should be “consistent across the whole investment chain, covering information from both investment firms and the companies they invest in.” Standardization of disclosures is critical to preclude “greenwashing” – mainly a number of practices that include the mislabeling, misrepresentation and mis-selling of financial products. Although Mr. Maijoor referenced the increasing importance of ESG ratings, he indicated that “the level of public scrutiny and supervision of them … is far from optimal.” Mr. Maijoor expressed his view that ESG rating agencies should be regulated and overseen by public sector authorities.
“ESG” refers to environmental, social and governance criteria for companies by which investors can assess the social impact of their investments. (Click here to access the Principles for Responsible Investment by the United Nations Global Compact and the Finance UNEP Imitative.) Mr. Maijoor delivered his speech before the European Financial Forum in Dublin.
- Rapid and Effective Remediation Coordinated With Regulator May Lead to Reduced Sanctions Says FCA Enforcement Chief: In a recent speech discussing sanctions for regulatory breaches, Mark Steward, Executive Director of Enforcement and Market Oversight at the UK Financial Conduct Authority, indicated that the FCA “may impose tougher sanctions where we see firms failing to correct relevant deficiencies and make good market losses to customers” caused by regulatory breakdowns. Contrariwise, he said, FCA may also reduce sanctions and give credit for rapid, “pro-active” and thorough remediation undertaken in “cooperation” with the FCA (including customer restitution) when regulatory breaches are identified. In “rare cases,” noted Mr. Steward, “the quality, extent and speed of that redress may justify very significant reductions in sanctions.”
In September 2017, James McDonald, Director of the Division of Enforcement of the Commodity Futures Trading Commission, said that potential wrongdoers who voluntarily self-report their violations, fully cooperate in any subsequent CFTC investigation, and fix the cause of their wrongdoing to prevent a recurrence will receive “substantial benefits” in the form of significantly lesser sanctions in any enforcement proceeding and “in truly extraordinary circumstances,” no prosecution at all. (Click here for background in the article “New Math: Come Forward + Come Clean + Remediate = Substantial Settlement Benefits Says CFTC Enforcement Chief” in the October 1, 2017 edition of Bridging the Week.) Contemporaneously with his speech, the CFTC’s DOE released a formal Updated Advisory on Self Reporting and Full Cooperation that memorialized and expanded the elements of Mr. McDonald’s presentation (click here to access).
- SEC Proposes Enhanced Data Regarding National Market Stock Trades Be Made Available to All Investors: The Securities and Exchange Commission proposed changes that, if adopted, would augment the information made publicly available regarding all national market stock transactions, and potentially increase the number of persons eligible to provide such information to investors, thereby enhancing competition. As proposed, the SEC is recommending a new model of data distribution that eliminates provision of each national stock information to an exclusive processor and instead requires each self-regulatory organization to make available all of its stock data to competing consolidators and self-aggregators. Additionally, instead of just a national best bid and offer and last sale information for each stock as is available today, the new rule proposes additional new information to be made available: information about orders in share amounts smaller than the current 100 lot size; certain depth of book data (i.e., information beyond just best bid and offer); and information regarding orders involved in market openings, closings, and other auctions. The SEC said such amendments are warranted by changes in equity market structure since the late 1970s when today's rules governing data dissemination were initially adopted. Then trading was mostly conducted on "relatively slow manual markets" where a stock's trading tended to be concentrated on the listing exchange. Today equity markets are electronic and trading in any one stock tends to be dispersed among different market centers. The SEC said its proposal would help level the latency in the timing of information obtained by high-speed traders and other investors and traders.
- SEC and CFTC Seek FY 2021 Budget Increases – CFTC for Virtual Currency Enforcement and Clearinghouse Reviews, SEC for Activities Involving Cybersecurity: Both the Securities and Exchange Commission and the Commodity Futures Trading Commission filed requests with Congress last week asking for increases to their annual budgets for the fiscal year beginning October 1, 2020 (FY 2021) compared to current year levels (FY 2020); these increases would, among other things, fund increased employee hiring at both agencies. The SEC sought an almost 5 percent increase in its budget for operations from approximately US $1.8 billion to US $1.89 billion, entailing a proposed increase in full-time equivalent employees from 4,459 to 4,590 from FY 2020 to FY 2021. The CFTC requested a 7 percent increase in funding from US $284 million to US $304 million, which includes a proposed increase in 15 FTE from 707 to 717 employees from FY 2020 to FY 20201. The SEC said it required increased funding to respond to “continued evolution and innovation in our securities markets” and to assess and secure its use of data, including addressing cybersecurity, data analytics, and EDGAR enhancements. The CFTC also justified, in part, its request for increased funding by pointing to its proposed information technology enhancements; increased costs associated with enforcement and oversight activities related to virtual currencies; and the need to examine more frequently regulated clearinghouses dealing in digital asset products.
For further information:
CFTC DSIO Director Issues Statement Offering Assistance to Pooled Vehicles and Asset Managers Trading Derivatives on Virtual Currencies:
DOJ, CFTC and SEC File Coordinated Legal Actions Against Purported Digital Asset Scam Aimed at Physicians:
Food Groups and CFTC DOE Again Poised to Settle 2015 Enforcement Action; Potential Contempt Finding Against Commission Hovering:
IOSCO Suggests Key Considerations for International Regulators With Oversight Over Cryptoasset Trading Platforms:
NFA Identifies Regulatory Deficiencies Often Identified During Examinations of Members:
SEC and CFTC Seek FY 2021 Budget Increases – CFTC for Virtual Currency Enforcement and Clearinghouse Reviews, SEC for Activities Involving Cybersecurity:
SEC Proposes Enhanced Data Regarding National Market Stock Trades Be Made Available to All Investors:
Trans-European Financial Regulator Urges Disclosure Standards Uniformity for Financial Services Firms Touting ESG: