[co-author: Shayonna Cato]

This is the eighth part in our 2023 series examining important trends in white collar law and investigations. Up next: anti-corruption.

Key Takeaways:

• As we predicted in our March 2022 post, 2022 was a year of heavy cryptocurrency enforcement, with a spike in actions by the U.S. Securities and Exchange Commission (the “SEC”) and the U.S. Commodity Futures
•  Trading Commission (the “CFTC”) against companies and individuals involved in cryptocurrency. It was also a year of major setbacks for the cryptocurrency industry, including the crash of the stablecoin TerraUSD (a cryptocurrency pegged to the value of the U.S. dollar that used an algorithm to control price fluctuation) and, shortly thereafter, the bankruptcy of the major cryptocurrency exchange FTX.
• The SEC and CFTC show no signs of slowing down their enforcement activities in 2023. But their approaches to enforcement have diverged, giving rise to what some see as a “good cop, bad cop” dichotomy: while the SEC continues to pursue perceived misconduct on a case-by-case basis against any crypto entity it believes offers a “security,” the CFTC is seeking express authority from Congress to expand its jurisdiction to fill regulatory gaps.
• The SEC’s active approach to crypto enforcement on a case-by-case basis, which recently included adding securities fraud charges against a defendant indicted for insider trading, has led to continued accusations that the agency is pursuing regulation by enforcement instead of promulgating clear rules that the industry can understand and follow.

The tumultuous crypto events of 2022, combined with the heightened agency and executive action we have seen so far in 2023, could potentially spur Congress to act by passing one of the many cryptocurrency bills that have been introduced.

The SEC and the CFTC Continue to Dominate Crypto Enforcement

The SEC and CFTC each announced a record-breaking number of crypto enforcement actions in 2022.  Jurisdiction over crypto activities, while messy, generally depends on whether the particular product or technology is a security (within the SEC’s remit), a derivative or commodity (the CFTC’s domain), or a currency (left to the Treasury Department).  And while both the SEC and CFTC have been ramping up their enforcement, the SEC has expressed more confidence about the current scope of its enforcement authority over crypto assets.  SEC Commissioner Gary Gensler believes most cryptocurrencies are securities that are already within the SEC’s purview, and has stated that crypto legislation should focus on stablecoins and granting the CFTC additional regulatory authority over digital assets that are not securities.  CFTC Chairman Rostin Behnam agrees that the CFTC should fill the regulatory gap over non-security cryptocurrencies and that Congress should expressly grant it that authority.

The SEC

In 2022, the SEC announced 30 crypto-related enforcement actions (its highest number ever and a 50% increase from the 20 actions brought in 2021) and imposed $242 million in monetary penalties.  Further, in 2022, the SEC charged a total of 79 respondents in cryptocurrency enforcement actions, of which 56 (71%) were individuals and 23 (29%) were firms.  Gensler has repeatedly highlighted cryptocurrency as an enforcement priority, and he is now under pressure from Congress to take on crypto issues affecting investors following the bankruptcy of FTX.  So we can expect to see heightened levels of crypto enforcement from the SEC in 2023.

On February 9, 2023, the SEC pushed the crypto exchange Kraken out of the business of providing interest to U.S. retail investors who loaned it cryptocurrency (a process known as staking).  The SEC took the position that a staking product amounts to a securities offering, which should be registered with the SEC and should meet disclosure standards.  Similar services are offered to U.S. customers from exchanges including Gemini, Binance.US, and Coinbase.  But questions remain whether the SEC is more broadly targeting all staking in the United States, how crypto companies can permissibly offer staking services, and whether the SEC will offer any guidance to companies that offer these services and do not want to be the SEC’s next target.

Under Gensler, the SEC has been pursuing individuals at a higher rate.  During the period of 2013-2020, on average, 20% of the agency’s enforcement actions targeted individuals as opposed to entities.  That rate rose to 35% in 2021 and reached 50% in 2022.  The SEC scored a high-profile settlement in early 2023: on February 17, it announced that NBA champion and former Boston Celtics player Paul Pierce had agreed to pay more than $1.4 million for allegedly making false and misleading statements about a cryptocurrency and sharing these statements on social media without disclosing his promotion fee.

The CFTC

Like the SEC, the CFTC’s crypto enforcement numbers have been on the rise.  In 2022, the CFTC announced 18 enforcement actions involving digital assets, up 73% from 11 actions in 2021 and representing more than 20% of all actions filed in 2022.  In 2023, the CFTC will likely continue targeting platforms offering cryptocurrency derivatives based on theories that those companies have engaged in unlawful commodity transactions or failed to register with the CFTC.

On February 3, 2023, Chairman Behnam praised the 69 digital enforcement actions that had been brought by the CFTC to date during a speech to the American Bar Association.  Behnam has been outspoken in his calls for greater crypto regulation, as well as his requests for congressional action to expand the CFTC’s jurisdiction and increase its budget to allow it to play a larger role in crypto enforcement.  According to Benham, the CFTC wants to conduct more effective due diligence on businesses and grow its enforcement team.

Increased Action by Executive Agencies

While the SEC and the CFTC have been (and will likely remain) the two heavyweights in crypto enforcement, executive agencies have also been expanding their reach in this area.  For example, the U.S. Department of the Treasury has continued to regulate the use of cryptocurrencies in international transactions.  Recently, the Office of Foreign Asset Controls settled with crypto companies Bittrex and Kraken over alleged sanctions violations.  Even the IRS is in mix, with its Criminal Investigation division hiring hundreds of new agents to work on digital assets and cybercrime.

The U.S. Department of Justice (“DOJ”) remains committed to enforcing federal criminal laws against alleged violations related to cryptocurrency.  One highlight in 2022 was the prosecution of the first-ever cryptocurrency insider trading case.  Ishan Wahi, a former product manager at Coinbase Global, Inc. (“Coinbase”), pleaded guilty to two counts of conspiracy to commit wire fraud in connection with an alleged scheme to commit insider trading in cryptocurrency assets.  His brother Nikhil Wahi had previously pleaded guilty to one count of conspiracy to commit wire fraud and was sentenced to 10 months in prison.  While most insider trading cases are based on allegations of securities fraud, these indictments were based exclusively on wire fraud charges, which allowed DOJ to leave unaddressed the question of whether the crypto assets involved were securities.

But the SEC weighed in on that question, bringing a securities fraud action against the Wahi brothers in connection with the same conduct underlying the DOJ action.  In its complaint, the SEC characterized the nine tokens the brothers traded as investment contracts, spurring CFTC Commissioner Caroline D. Pham to criticize the SEC’s actions as a “striking example of ‘regulation by enforcement.’”  While the Wahis maintain that the tokens are not securities under the law, the comment by Pham – herself a government official – highlights the view, held by some, that the SEC’s tactics are overly aggressive.

In late January 2023, the White House released a statement setting forth the administration’s roadmap for mitigating crypto risks, piggybacking on last year’s Executive Order on Ensuring Responsible Development of Digital Assets.  The Biden administration highlighted the increase in enforcement by multiple agencies and called on Congress to take steps to expand regulators’ powers, and to strengthen transparency and disclosure requirements for cryptocurrency companies.

Signs of Emerging Legislation from Congress

It is possible that, in 2023, we may finally see congressional action on crypto.  Notable legislation that has been introduced includes the bipartisan Lummis-Gillibrand Responsible Financial Innovation Act and the Digital Commodities Consumer Protection Act, both of which would give the CFTC the lead role in regulating crypto.  In the Senate, lawmakers introduced the Digital Asset Anti-Money Laundering Act, which would apply current anti-money laundering and financing terrorism prevention methods to the crypto industry, and the Stablecoin Trust Act, which would establish a federal regulatory framework for payment stablecoins.

In the House, there’s the Keep Your Coins Act, legislation that would preserve an individual’s right to privacy when transacting with digital assets, and the Crypto Exchange Disclosure Act, a law that would mandate disclosure requirements for crypto exchanges. Finally, the Crypto Consumer Investor Protection Act, another House bill, would prohibit crypto exchanges from using customer funds in certain ways if the customer has not consented.

Both Republicans and Democrats have expressed a desire to increase scrutiny over the industry.  If Congress remains resolved to act and the Biden administration continues to highlight the improvements needed in the crypto enforcement area, we could eventually see a more regulated and transparent industry, with increased market stability and investor protection.  Until then, crypto companies will have to look to past and current enforcement actions to see where the federal government is drawing the lines, and will need to continue exercising heightened levels of caution in this space.