Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.
Illinois announces new consumer protections for digital assets, proposes new money transmitter licensing provisions
On February 21, the Illinois Department of Financial and Professional Regulation (IDFPR) announced several legislative initiatives to establish consumer protections for cryptocurrencies and other digital assets and provide regulatory oversight of the broader digital asset marketplace. The Fintech-Digital Asset Bill (see HB 3479) would create the Uniform Money Transmission Modernization Act and provide for the regulation of digital asset businesses and modernize regulations for money transmission in the state. Among other things, the Fintech-Digital Asset Bill would require digital asset exchanges and other digital asset businesses to obtain a license from IDFPR to operate in the state. The bill also establishes various requirements for businesses, including investment disclosures, customer asset safeguards, and customer service standards. Companies would also be required to implement cybersecurity measures, as well as procedures for addressing business continuity, fraud, and money laundering. Notably, the Fintech-Digital Asset Bill replaces and supersedes the Transmitters of Money Act (see 205 ILCS 657) with the Money Transmission Modernization Act, in order to harmonize the licensing, regulation, and supervision of money transmitters operating across state lines. Provisions also amend the Corporate Fiduciary Act to allow for the creation of trust companies for the special purpose of acting as a fiduciary to safeguard customers’ digital assets, the announcement noted.
The Consumer Financial Protection Bill (see HB 3483) would grant the IDFPR authority to enforce the Fintech-Digital Asset Bill and strengthen the department’s authority and resources for enforcing existing consumer financial protections. Modeled after the Dodd-Frank Act, the Consumer Financial Protection Bill empowers the IDFPR with the ability to target unfair, deceptive, and abusive acts and practices by unlicensed financial services providers. The bill creates the Consumer Financial Protection Law and the Financial Protection Fund, and establishes provisions related to supervision, registration requirements, consumer protection, cybersecurity, anti-fraud and anti-money laundering, enforcement, procedures, and rulemaking. The Consumer Financial Protection Bill also includes provisions concerning court orders, penalty of perjury, character and fitness of licensees, and consent orders and settlement agreements, and makes amendments to various application, license, and examination fees. The bill does so by amending the Collection Agency Act, Currency Exchange Act, Sales Finance Agency Act, Debt Management Service Act, Consumer Installment Loan Act, and Debt Settlement Consumer Protection Act.
DFPI launches crypto scam tracker
On February 16, the California Department of Financial Protection and Innovation (DFPI) launched a database to help consumers in the state spot and avoid crypto scams. The Crypto Scam Tracker compiles details about apparent crypto scams identified through a review of public complaints submitted to the DFPI, and is searchable by company name, scam type, or keywords. “Through the new Crypto Scam Tracker, combined with rigorous enforcement efforts, the DFPI is committed to shining a light on these ruthless predators and protecting consumers and investors,” DFPI Commissioner Clothilde Hewlett said in the announcement.
NYDFS adds enhancements for detecting virtual currency fraud
On February 21, NYDFS Superintendent Adrienne A. Harris announced enhancements to the Department’s ability to detect fraud in the virtual currency industry. The new enhancements will improve NYDFS’s ability to combat financial crime and detect illegal activity among state-regulated entities engaged in virtual currency activity through new insider trading and market manipulation risk monitoring tools. Specifically, the enhancements will strengthen NYDFS’s virtual currency supervision and aid the Department in detecting potential insider trading, market manipulation, and front-running activity associated with regulated entities’ and applicants’ exposure or potential exposure to listed virtual currency wallet addresses. The announcement builds upon recently issued guidance related to the use of blockchain analytics tools, the issuance of U.S. dollar-backed stablecoins, and custodial guidance on crypto insolvency, as well as guidance for addressing measures for preventing market manipulation. (Covered by InfoBytes here, here, here, and here.)
Treasury official highlights fintech, crypto assets, and cloud services challenges
On February 15, Treasury Assistant Secretary for Financial Institutions Graham Steele delivered remarks before the Exchequer Club of Washington, D.C., during which he discussed the U.S. Treasury Department’s financial institutions agenda on fintech, cryptocurrency, and cloud service providers. Stating that “significant potential exists to harness the underlying technology in fintech, digital assets, and cloud services adoption,” Steele cautioned that there exist common risks across these spaces related to inadequate oversight, excessive concentration, and consumer harms.
With respect to nonbanks and fintech, Steele noted that participation by nonbanks in financial services is a key priority for Treasury. He commented that while nonbanks add diversity and competition pressure to consumer finance markets, they “have largely not been subject to the kind of comprehensive regulation and supervision to which banks are subject,” which has created numerous “risks related to regulatory arbitrage, data privacy and security, bias and discrimination, and consumer protection, among others.” Steele highlighted recent Treasury recommendations primarily focused on using existing authorities held by the federal banking regulators and the CFPB as a way to coordinate supervision of bank-fintech partnerships and credit underwriting models. Another area of concern, Steele noted, are big technology firms—those that generally seek to enter the consumer finance market via relationships with banks and third-party fintech firms, and who avoid prudential regulation, supervision, and risk-management requirements that would apply if they offered banking services. “Big Tech firms may have incentives to leverage their existing commercial relationships, consumer data, and other resources to enter new markets, expand their networks and offerings, and scale rapidly to achieve capabilities that others—including depository institutions—do not have and cannot replicate,” Steele said.
Steele also touched on Treasury’s objectives for crypto assets, in which he referred to several studies examining “the potential financial stability implications of crypto-asset activities” and the risks and opportunities they might present to consumers, investors, and businesses. He also addressed concerns about misleading claims and representations in this space (for example, with respect to the availability of deposit insurance) and noted that there exist several gaps in existing authorities over crypto assets. Finally, Steele discussed a recent Treasury report, which examined potential benefits and challenges associated with the adoption of cloud services technology by financial services firms (covered by InfoBytes here).
SEC proposes new protections for crypto assets
On February 15, the SEC proposed new rules to enhance protections for customer assets, including cryptocurrency assets, managed by registered investment advisers. (See also SEC Fact Sheet here.) The proposed rules would implement measures under the Investment Advisers Act of 1940 to address how client assets are safeguarded, and would broaden the definition of “asset class” to ensure investment advisers are protecting not only their clients’ securities and funds but also “other positions held in a client’s account,” including crypto assets.
Under the proposed rules, investment advisers would be required to, among other things, segregate such crypto assets into separate accounts for safekeeping, prevent commingling of assets with the adviser’s or another related persons’ assets, and place crypto assets with a qualified custodian such as a federal or state-chartered bank or savings association, a registered broker-dealer or futures commission merchant, or certain foreign financial institutions. Foreign financial institutions would have to adhere to enhanced requirements to serve as a qualified custodian.
In a statement accompanying the release of the proposed rules, SEC Chairman Gary Gensler stated that “advisers who trade an investor’s assets cannot circumvent the custody rule and the safeguards it provides.” Gensler added that the proposal would impose several recordkeeping requirements, and require, for the first time, that advisers and qualified custodians enter into written agreements to help guarantee that customer assets are being protected.
Comments on the proposed rules are due 60 days after publication in the Federal Register.
FDIC orders entities to stop making fraudulent deposit insurance representations
On February 15, the FDIC sent letters to four entities demanding that they stop making false or misleading representations about FDIC deposit insurance. Letters were sent to a cryptocurrency exchange and to a nonbank financial services provider demanding that the entities cease and desist from making false and misleading statements about FDIC deposit insurance and take immediate corrective action to address these statements. The FDIC also sent letters to two websites ordering them to remove similar false and misleading statements claiming that the crypto exchange and the nonbank financial services provider are FDIC-insured and that FDIC insurance will protect customers’ cryptocurrency or protect customers in the event of the nonbank’s failure. Under the Federal Deposit Insurance Act, persons are prohibited “from representing or implying that an uninsured product is FDIC-insured or from knowingly misrepresenting the extent and manner of deposit insurance.”
Fed cautions banks regarding crypto risks
On February 10, Federal Reserve Board Governor Christopher J. Waller gave a speech on the cryptocurrency ecosystem and digital assets before attendees at the Global Interdependence Center Conference: Digital Money, Decentralized Finance, and the Puzzle of Crypto. Waller provided a broad overview of digital assets and digital ledger technologies and briefly discussed the use of smart contracts in peer-to-peer trading, as well as their potential to automate the execution of certain transactions in non-crypto-assets such as securities transactions. He also highlighted risks associated with another emerging technology—tokenization—which, he explained, “when combined with data vaults to securely store personal information, can be used to trade objects in a way that protects one’s identity from being exploited for profit.” Waller commented that these potential applications could also “lead to substantial productivity enhancements in other industries” beyond the crypto ecosystem.
Waller went on to express support for prudent innovation but expressed concerns about banks engaging in activities that expose them to a heightened risk of fraud, scams, and legal uncertainties. “As with any customer in any industry, a bank engaging with crypto customers would have to be very clear about the customers’ business models, risk-management systems, and corporate governance structures to ensure that the bank is not left holding the bag if there is a crypto meltdown,” Waller stated. “And banks considering engaging in crypto-asset-related activities face a critical task to meet the ‘know your customer’ and ‘anti-money laundering’ requirements, which they in no way are allowed to ignore.”
Senators exploring bank’s dealings with collapsed crypto exchange
On January 30, Senators Elizabeth Warren (D-MA), John Kennedy (R-LA), and Roger Marshall (R-KS) sent a follow-up letter to a California-based bank asking for additional responses to questions related to the bank’s relationship with several cryptocurrency firms founded by the CEO of a now-collapsed crypto exchange. As previously covered by InfoBytes, the senators pressed the CEO for an explanation for why the bank failed to monitor for and report suspicious transactions to the Financial Crimes Enforcement Network, and asked for information about how deposits it was holding on behalf of the collapsed exchange and related firm were being handled. The senators stressed that the bank has a legal responsibility under the Bank Secrecy Act to maintain an effective anti-money laundering program that may have flagged suspicious activity.
In the letter, the senators accused the bank of evading their previous questions in its December response, writing that while the bank’s answers confirm the extent of its failure to monitor and report suspicious financial activity, it failed “to provide key information needed by Congress to understand why and how these failures occurred.” The bank’s “repeated reference to ‘confidential supervisory information’” as a justification for its refusal to provide the requested information “is simply not an acceptable rationale,” the senators said. They also noted that the bank’s recent advance from the Federal Home Loan Bank of San Francisco—intended “to ‘stave off a further run on deposits’”—has introduced additional crypto market risks into the traditional banking system, especially should the bank fail. The bank was asked to explain how it plans to use the $4.3 billion it received.
The senators further commented that additional findings have revealed that neither the Federal Reserve nor the bank’s independent auditors were able to identify the “extraordinary gaps” in the bank’s due diligence process. The senators asked the bank to provide responses to questions related to its risk management policies, as well as how many safety and soundness exams were conducted, and whether any of the bank’s executives were “held accountable” for the failures related to the collapsed exchange, among other things.
Biden administration presents roadmap for mitigating crypto risks
On January 27, the Biden administration presented a roadmap for mitigating cryptocurrency risks to ensure that cryptocurrencies do not undermine financial stability, investors are protected, and bad actors are held accountable. At President Biden’s direction, the administration previously laid out a comprehensive framework for developing digital assets in a safe, responsible way that also identifies clear risks. (Covered by InfoBytes here.) The administration identified clear risks taken by some crypto entities, such as ignoring applicable financial regulations and basic risk controls, misleading consumers, having conflicts of interest, failing to provide adequate disclosures, or committing fraud. The roadmap also outlined actions taken by the federal banking agencies, including a recently issued joint interagency statement that highlighted key risks banks should consider when choosing to engage in crypto-related services and a notice of proposed rulemaking issued by the FDIC warning companies against making false or misleading claims about digital assets being insured by the agency (covered by InfoBytes here and here). The administration also noted that agencies across the government are developing public-awareness programs to help consumers understand the risks associated with digital assets.
The administration stressed, however, that further action is needed. Priorities for digital asset research and development will be unveiled in the coming months, the administration said, adding that Congress should also step up efforts in this space. This includes expanding regulators’ powers to prevent misuses of customers’ assets, “strengthen[ing] transparency and disclosure requirements for cryptocurrency companies so that investors can make more informed decisions about financial and environmental risks,” “strengthen[ing] penalties for violating illicit-finance rules and subject cryptocurrency intermediaries to bans against tipping off criminals,” and limiting crypto risks to the financial system by following steps outlined in a recent Financial Stability Oversight Council report (covered by InfoBytes here), the administration said.
Fed says limits on banking activities will apply regardless of insurance status
On January 27, the Federal Reserve Board issued a policy statement providing guidelines on how the agency evaluates requests from supervised uninsured and insured banks seeking to engage in novel activities, such as those involving crypto assets. Recognizing that in recent years the Fed has received numerous inquiries, notifications, and proposals from banks seeking to engage in new or unprecedented activities, the Fed clarified that when evaluating such inquiries, uninsured and insured banks supervised by the Fed would be subject to the same limitations that are currently imposed on OCC-supervised national banks, including crypto-asset-related activities. According to a board memo published the same day, the Fed said it “will presumptively exercise its authority to limit state member banks to engaging as principal in only those activities that are permissible for national banks—in each case, subject to the terms, conditions, and limitations placed on national banks with respect to the activity—unless those activities are permissible for state banks by federal law.” This “equal treatment” is intended to “promote a level playing field and limit regulatory arbitrage,” the Fed said.
The Fed reiterated that banks must be able to ensure that any activities they plan to engage in are permitted by law and conducted in a safe and sound manner. A bank should implement risk management processes, internal controls, and information systems that are “appropriate and adequate for the nature, scope, and risks of its activities,” the Fed noted. The Fed, however, explained that the policy statement does “not prohibit a state member bank, or prospective applicant, from providing safekeeping services, in a custodial capacity, for crypto-assets if conducted in a safe and sound manner and in compliance with consumer, anti-money laundering, and anti-terrorist financing laws.”
The policy statement was issued the same day the Fed denied a request from a Wyoming-based digital asset firm to become a member of the Federal Reserve System. The Fed explained that the firm—a special purpose depository institution chartered by the state of Wyoming that “proposed to engage in novel and untested crypto activities that include issuing a crypto asset on open, public and/or decentralized networks…“ presented significant safety and soundness risks.” Additionally, the Fed determined that the digital asset firm’s risk management framework failed to sufficiently address heighted risk concerns, including its ability to mitigate money laundering and terrorism financing risks.
- Keisha Whitehall Wolfe to discuss “Tips for successfully engaging your state regulator” at the MBA's State and Local Workshop
- Max Bonici to discuss “Enforcement risk and trends for crypto and digital assets (Part 2)” at ABA’s 2023 Business Law Section Hybrid Spring Meeting
- Jedd R. Bellman to present “An insider’s look at handling regulatory investigations” at the Maryland State Bar Association Legal Summit