Eastern District Of New York Grants Preliminary Injunction In Opinion Backing CFTC's Authority To Regulate Cryptocurrency

by Shearman & Sterling LLP

On March 6, 2018, Judge Jack B. Weinstein of the United States District Court for the Eastern District of New York entered a preliminary injunction against a virtual currency company and its owner in connection with an alleged fraudulent virtual currency scheme.  CFTC v. McDonnell, et al., No. 1:18-cv-00361 (E.D.N.Y. Mar. 6, 2018).  Judge Weinstein found that the Commodity Futures Trading Commission (“CFTC”) had shown a reasonable likelihood that defendants would continue to violate the Commodity Exchange Act (“CEA”).  In so ruling, Judge Weinstein became the latest judge to recognize the CFTC’s authority to regulate cryptocurrencies as commodities.

On January 18, 2018, the CFTC filed a federal civil enforcement action against Patrick K. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets (“CDM”), charging them with fraud and misappropriation in connection with purchases and trading of certain virtual currencies.  The CFTC complaint alleged that from approximately January 2017 to the present, McDonnell and CDM engaged in a deceptive and fraudulent scheme to induce customers to send money and virtual currencies to CDM, purportedly in exchange for real-time virtual currency trading advice and for virtual currency purchasing and trading on behalf of the customers under McDonnell’s direction.  In fact, as alleged in the complaint, the supposedly expert, real-time virtual currency advice was never provided, and customers who provided funds to McDonnell and CDM to purchase or trade on their behalf never saw those funds again.  In short, McDonnell and CDM allegedly used their fraudulent solicitations to obtain and then misappropriate customer funds.

Judge Weinstein’s decision addresses arguments by McDonnell that the CFTC lacks the authority to regulate cryptocurrencies as commodities.  The question of which U.S. regulators have the authority to regulate cryptocurrencies has become an increasingly important issue as virtual currencies have greatly increased in popularity.  In the absence of any clear legislation on the subject, multiple U.S. regulators have claimed overlapping and concurrent jurisdiction.  The CFTC, for example, has defined virtual currencies as commodities.  Similarly, the SEC has taken the position that it can regulate cryptocurrencies as securities.  These jurisdictional claims are now coming under scrutiny from the courts, as defendants in cryptocurrency-related cases have raised the issue in attempts to dismiss charges against them.

In the opinion granting the CFTC’s motion for preliminary injunction, Judge Weinstein touched on a number of aspects of the current regulatory regime, ranging from the sources of the CFTC’s authority to the nature of cryptocurrencies themselves and whether they should indeed be considered commodities.  Judge Weinstein concluded that cryptocurrencies are properly considered to be commodities, and therefore fall under the purview of the CFTC’s regulatory authority.  Judge Weinstein was careful to note, however, that his decision does not argue that no other regulatory agency has the authority to regulate cryptocurrencies.  Rather, other agencies have the authority to regulate cryptocurrencies that “function differently than derivative commodities.”  Opinion at *24.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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