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CFTC Files Anti-Fraud Enforcement Action Against New York-Based Corporation Concerning Bitcoin Investments
On September 21, the U.S. Commodity Futures Trading Commission (CFTC) filed a complaint in the U.S. District Court for the Southern District of New York against a New York-based corporation and its CEO (defendants) for allegedly engaging in fraudulent acts and practices in violation of the Commodity Exchange Act and CFTC Regulations by issuing false account statements in connection with Bitcoin investment solicitations. According to the complaint, the “Bitcoin Ponzi scheme” solicited more than $600,000 from approximately 80 customers to be placed in a pooled fund, executed by the defendants’ computer program called “Jigsaw,” which traded the virtual currency. The CFTC alleges that defendants’ strategy was fake and the “purported performance reports” were false in that they created the appearance of positive Bitcoin trading increases, but the gains were “illusory.” The CFTC further asserts that the “payouts of supposed profits to [pool participants] in actuality consisted of other customers’ misappropriated funds.” In addition, the CFTC alleges that defendants orchestrated a “fake computer ‘hack’” to conceal the scheme. The suit seeks, among other things, disgorgement of profits, civil monetary penalties, restitution, and a ban on commodities trading for the defendants.
China Bans Commercial Trading of Initial Coin Offerings
On September 4, the People’s Bank of China and several Chinese regulators reportedly jointly announced plans to ban the commercial trading of bitcoin and other cryptocurrencies. This measure, announced in a statement issued by the Ministry of Industry and Information Technology of the People’s Republic of China, will outlaw all fundraising Initial Coin Offerings (ICOs), and declares ICOs and the sale of virtual currency as unauthorized illegal financing behavior, suspected of illegal sale tokens, illegal securities issuance, and illegal fund-raising, including financial fraud, pyramid schemes and other criminal activities. The statement reportedly stresses that virtual currency in China will not be recognized as a legal form of currency and must not be circulated as currency when financing activities. Furthermore, going forward, all cryptocurrency trading platforms are prohibited in China from acting as central counterparties to facilitate the exchange of tokens for virtual currencies. Additionally, one of China’s bitcoin exchanges reportedly published an announcement on its website saying it will close its bitcoin currency trading platform in the country on September 30.
The SEC recently released an investor bulletin about ICO investment risks and offered fraud prevention guidance. (See previous InfoBytes summary here.) ICO sales are often used to raise capital, and the SEC is monitoring companies who use this method for fraudulent purposes.
Legislation Introduced to Make Bitcoin Purchases up to $600 Tax-Exempt
On September 7, Representatives Jared Polis (D-Colo.) and David Schweikert (R-Ariz.)—co-chairs of the Congressional Blockchain Caucus—introduced the Cryptocurrency Tax Fairness Act of 2017 to allow for tax and IRS reporting requirements exemptions on cryptocurrency transactions of up to $600. The bill is in response to an IRS notice issued in 2014 that held that virtual currency, such as bitcoin and other forms of cryptocurrency, must be treated as property for U.S. federal tax purposes. According to a press release issued by Rep. Polis’ office, this “outdated guidance classifies even the smallest of cryptocurrency transactions the same as buying or selling stock, which dis-incentivizes consumers from using virtual currencies to pay for goods and services.” The bill proposes amending the Internal Revenue Code to exclude up to $600 of “gain from the sale or exchange of virtual currency for other than cash or cash equivalents” from gross income and ordering the Treasury Department to create “regulations providing for information returns on virtual currency transactions for which gain or loss is recognized.”
FinCEN, California U.S. Attorney Assess Civil Money Penalties Against Virtual Currency Transmitter and Operator for AML Violations
On July 27, the Financial Crimes Enforcement Network (FinCEN), in partnership with the U.S. Attorney’s Office for the Northern District of California, assessed a more than $110 million civil money penalty against an internet-based, foreign-located virtual currency transmitter for willfully violating the anti-money laundering (AML) provisions of the Bank Secrecy Act. A second, separate $12 million penalty was assessed against one of the company’s operators, a Russian national. Additionally, a California grand jury handed down a 21-count indictment against the currency transmitter and the Russian national. According to allegations, the company exchanged fiat currency in addition to virtual currencies such as bitcoin, and “facilitated transactions involving ransomware, computer hacking, identity theft, tax refund fraud schemes, public corruption, and drug trafficking.” The company also processed transactions using stolen funds.
Pursuant to the terms of the assessment, from November 2011 through the present, both the company and the operator allegedly failed to (i) meet money services business (MSB) registration requirements; (ii) implement an effective AML program; (iii) detect suspicious transactions or file suspicious activity reports; and (iv) obtain and retain records for transmitted funds of $3,000 or more. FinCEN warned that regardless of ownership or location, foreign-located MSBs are “required to comply with U.S. AML laws and regulations . . . including AML program, MSB registration, suspicious activity reporting, and recordkeeping requirements.”
This is the first action FinCEN has taken against a foreign-located MSB conducting business in the U.S.
CFTC Approves First Digital Currency Derivatives Exchange
On July 24, the Commodity Futures Trading Commission (CFTC) announced its approval, by unanimous vote, of the first digital currency derivatives exchange under the Commodity Exchange Act. The CFTC issued a letter and order granting the registration, allowing the company to provide clearing services for fully-collateralized digital currency swaps, but noted that the authorization to provide clearing services for fully-collateralized digital currency swaps did not constitute or imply a CFTC endorsement of the use of digital currency generally, or bitcoin specifically. Based on the company’s representations related to having collateral already on deposit to cover the maximum possible loss, the CFTC exempted the company from certain regulations calling for, among other things, monthly stress-testing and specific daily reporting requirements. The company initially plans to clear bitcoin options.
Florida Adds Virtual Currency to Anti-Money Laundering Law
On June 23, Florida Governor Rick Scott signed H.B. 1379, which will incorporate virtual currency into the Florida Money Laundering Act. Specifically, the Bill adds virtual currency to the list of currency and negotiable instruments classified as “monetary instruments” under the Act. In addition, virtual currency will be included in the definitions section as a “medium of exchange in electronic or digital format that is not a coin or currency of the United States or any other country.” The law goes into effect on July 1.
NYDFS Authorizes Coinbase to Offer Trading of Digital Currencies in New York
On March 22, the New York State Department of Financial Services (NYDFS) announced the approval of Coinbase, Inc.’s application to offer Ether and Litecoin to New York customers. “Ether” is a “digital cryptography-based asset” of the Ethereum network, “similar to how bitcoin is the digital cryptography-based asset of the Bitcoin network.” Litecoin, developed as a modification of the Bitcoin protocol, is the first alternative virtual currency to Bitcoin to gain public acceptance. NYDFS also approved Coinbase’s linked debit card service “Shift Card”—a VISA debit card that allows Coinbase users in select U.S. states and territories to use Bitcoin anywhere VISA is accepted. As discussed in a previous InfoBytes post, NYDFS recently issued a virtual currency and money transmitter license to Coinbase, which permits the company to operate as a service for buying, selling, sending, receiving, and storing Bitcoin. Financial Services Superintendent Maria T. Vullo noted, “DFS has proven that the state regulatory system is the best way to supervise and cultivate a thriving fintech industry, like virtual currency. New York will remain steadfast in pushing back against federal encroachment efforts like the OCC’s proposal to impose a one-size-fits-all national bank charter that increases risk and seeks to usurp state sovereignty.”
Virtual Currency Added to Utah’s Unclaimed Property Act
In March, Utah passed SB 175 amending its Unclaimed Property Act. Among the changes incorporated through the new law was the expansion of the law’s coverage to include “virtual currency”—a term the law defines as “a digital representation of value used as a medium of exchange, unit of account, or store of value, which does not have legal tender status recognized by the United States.” Notably, this definition explicitly excludes “(i) the software or protocols governing the transfer of the digital representation of value; (ii) game-related digital content; (iii) a loyalty card; (iv) membership rewards” and “(v) a gift card.” Virtual currency subject to Utah law must be turned over to the state’s treasury after it has been “presumed abandoned” for a prescribed period of time. The law contains a detailed test for when property has been presumed abandoned, when the clock starts ticking, and under what circumstances that clock may be paused and/or reset. In a March 15 press release, Utah Treasurer David Damschen, “applauded the final passage of SB 175,” but also explained that “there are certain changes in the law related to properties held by the banking and insurance industries that we may still have to make,” including, for example “certain prepaid debit card account balances.”
SEC Denies Application for Bitcoin ETF Due to Lack of Regulation, Potential for Manipulation
On March 10, 2017, the SEC issued an Order disapproving of a proposed rule change by the BATS BZX Exchange (“the Proposal”), which proposed to list and trade “commodity-based trust shares” issued by the Winklevoss Bitcoin Trust. The Proposal, if approved, would have established a bitcoin exchange-traded fund (“ETF”) that market participants could invest in through the BATS BZX Exchange platform. Specifically, in rejecting the Proposal, the Commission emphasized the lack of regulation in the bitcoin market, noting both (i) that the BATS BZX Exchange platform “would currently be unable to enter into, the type of surveillance-sharing agreement that helps address concerns about the potential for fraudulent or manipulative acts and practices in the market for the Shares”; and (ii) that bitcoin regulation, at present, would leave a bitcoin ETF more susceptible to manipulation than an ETF comprised of other commodities, such as gold and silver. Ultimately, the Commission concluded that, “[a]bsent the ability to detect and deter manipulation of the Shares—through surveillance sharing with significant, regulated markets related to the underlying asset—the [Commission] does not believe that a national securities exchange can meet its” regulatory obligations.
Comments submitted in response to the original BATS BZX Exchange proposed rule change can be accessed here.
Coinbase Gets NY BitLicense, Clearance For Its Operations
On January 18, the New York State Department of Financial Services (NYDFS) announced that it had approved the application of Coinbase, Inc., for a virtual currency and a money transmitter license. According to NYDFS, the license was issued to Coinbase—a digital currency wallet that facilitates transactions with Bitcoin and other virtual currencies—only after “a comprehensive review of Coinbase’s applications, including the company’s anti-money laundering, capitalization, consumer protection, and cyber security policies.” Having met the New York regulator’s standards for operations in the state, Coinbase may now operate, under supervision by NYDFS, as a service for buying, selling, sending, receiving and storing Bitcoin.
As previously covered in InfoBytes, NYDFS’s BitLicense framework—which was finalized back in June 2015—requires virtual currency companies to submit a 31-page application providing information covering, among other things: (i) written policies and procedures including, but not limited to BSA/AML, cybersecurity, privacy and information security, (ii) company information, (iii) biographical information on company directors and stockholders, and (iv) an explanation of the methodology used to calculate the value of virtual currency in fiat currency. In addition, the NYDFS released a set of FAQs to help clarify the BitLicense requirements. To date, NYDFS has approved five firms for virtual currency charters or licenses, while denying those applications that did not meet its standards.