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On October 18, the SEC announced the launch of its Strategic Hub for Innovation and Financial Technology (FinHub). According to the SEC, FinHub will assist in facilitating public engagement on fintech-related topics, including blockchain/distributed ledger technology, digital marketplace financing, automated investment advice, and artificial intelligence/machine learning. Through FinHub, industry participants and the public will have the opportunity to engage directly with the SEC to discuss and test innovative ideas and technological developments. FinHub will also act as a clearinghouse for SEC staff to access and disseminate fintech-related information throughout the agency, and will “[s]erve as a liaison to other domestic and international regulators regarding emerging technologies in financial, regulatory, and supervisory systems.”
“FinHub provides a central point of focus for our efforts to monitor and engage on innovations in the securities markets that hold promise, but which also require a flexible, prompt regulatory response to execute our mission,” SEC Chairman Jay Clayton announced.
On May 15, Federal Reserve Board Governor Lael Brainard spoke at a digital currency conference sponsored by the Federal Reserve Bank of San Francisco to discuss how digital innovations may impact the financial system, specifically in the areas of payments, clearing, and settlement. Brainard discussed, among other things, the importance of understanding the impact these innovations may have on (i) investor and consumer protection issues, and (ii) cryptocurrency and distributed ledger technology governance, particularly with respect to Bank Secrecy Act/anti-money laundering concerns. In addition, Brainard commented on the inherent risks and challenges surrounding the concept of a central bank digital currency, and noted that at this time, “there is no compelling demonstrated need for a Fed-issued digital currency [because] [m]ost consumers and businesses in the U.S. already make retail payments electronically using debit and credit cards, payment applications, and the automated clearinghouse network. Moreover, people are finding easy ways to make digital payments directly to other people through a variety of mobile apps.” Brainard noted, however, that the Federal Reserve is monitoring these technological developments as “digital tokens for wholesale payments and some aspects of distributed ledger technology—the key technologies underlying cryptocurrencies—may hold promise for strengthening traditional financial instruments and markets” in the coming years.
On February 6, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled, “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission” to discuss the need for unified measures to close regulatory gaps in the cryptocurrency space. Committee Chairman Mike Crapo, R-Idaho, opened the hearing by briefly discussing the rise in interest in virtual currencies among Americans, as well as investor education and enforcement efforts undertaken by the SEC and the CFTC. Crapo commented that he was interested in learning how regulators plan to safeguard investors. Sen. Sherrod Brown (D-Ohio), ranking member of the Committee, spoke about the importance of pursuing “the unique enforcement of regulatory demands posed by virtual currencies.”
SEC Chairman Jay Clayton commented in prepared remarks that the SEC does not want to “undermine the fostering of innovation through our capital markets,” but cautioned that there are significant risks for investors when they participate in an entity’s initial coin offering (a method used to raise capital through decentralized autonomous organizations or other forms of distributed ledgers or blockchain technology) or buy and sell cryptocurrency with firms that are not compliant with securities laws. Speaking before the Committee, Clayton stated that the SEC has some oversight power in this space but supported collaborating with Congress and states on new regulations for cryptocurrency firms. “We should all come together, the federal banking regulators, CFTC, the SEC—there are states involved as well—and have a coordinated plan for dealing with the virtual currency trading market,” Clayton stressed.
In prepared remarks, CFTC Chairman Chris Giancarlo discussed different approaches to regulating distributed ledger technologies and virtual currencies. “‘Do no harm’ was unquestionably the right approach to development of the internet. Similarly, I believe that ‘do no harm’ is the right overarching approach for distributed ledger technology,” Giancarlo said. “Virtual currencies, however, likely require more attentive regulatory oversight in key areas, especially to the extent that retail investors are attracted to this space.”
Giancarlo referenced a joint op-ed in which the two chairmen discussed whether the “historic approach to the regulation of currency transactions is appropriate for the cryptocurrency markets,” and offered support for “policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era.” The chairmen also agreed that the lack of a clear definition for what cryptocurrencies are has contributed to regulatory challenges, but stressed that their agencies would continue to bring enforcement actions against fraudsters. Both the SEC and CFTC have joined a virtual currency working group formed by the Treasury Department—which also includes the Federal Reserve and the Financial Crimes Enforcement Network—to discuss cryptocurrency jurisdiction among the agencies and understand where the gaps exist.
See here for additional InfoBytes coverage on initial coin offerings and virtual currency.
On December 14, the Financial Stability Oversight Council (FSOC) released its 2017 annual report. The report reviews financial market developments, identifies emerging risks, and offers recommendations to enhance financial stability. Highlights include:
- Cybersecurity. The report notes that financial institutions need to work with regulators to improve cybersecurity resilience and better understand risks. FSOC encourages the creation of a private sector council of senior executives to work with government officials and focus on ways cyber incidents may affect business operations.
- Marketplace Lending. FSOC acknowledges that marketplace lending is still an evolving model with potential risks, such as the misalignment of incentives. However, the report notes the platform’s potential to reduce costs and expand access to credit.
- New Technology. The report discusses challenges for supervision and regulation of virtual currencies and distributed ledger technology. FSOC observes that current regulatory practices were designed for more centralized systems, in comparison to the decentralization of data storage in this new landscape.
SEC Obtains Emergency Court Order Against Canadian Firm for Allegedly Violating Federal Securities Law; Halts Initial Coin Offering
On December 4, the SEC announced it had obtained an emergency court order to freeze the assets of a Canadian company and the company’s founders (Defendants) and block Defendants’ ability to continue to raise funds through an initial coin offering (ICO). At the time the order was issued, the ICO had raised $15 million since August by “promising investors returns of 1,354% in under 29 days.” This is the first enforcement action taken by the SEC’s recently established Cyber Unit, whose focus includes distributed ledger technology and initial coin offering violations. (See previous InfoBytes Cyber Unit coverage here.)
According to a complaint filed December 1 in the U.S. District Court for the Eastern District of New York, Defendants allegedly violated the anti-fraud and registration provisions of U.S. federal securities laws by making a series of materially false and misleading statements when marketing and selling securities as digital tokens/cryptocurrencies to obtain investor funds. From August to the present, Defendants purportedly raised $15 million through the ICO, and made false representations including, among other things, that: (i) the firm consisted of large teams of experts across the globe, and (ii) investors would receive certain promised returns (1,354% in less than a month) on investments if all tokens were sold. Further, Defendants allegedly failed to disclose (i) that a portion of the proceeds from the ICO funds would pay personal expenses, and (ii) that the company’s principal executive was “a known recidivist securities law violator in Canada.” The SEC seeks relief in the form of permanent injunctions, monetary penalties and interest, and an “officer-and-director bar and a bar from offering digital securities” against the company’s founders.
On September 25, the SEC announced the expansion of its Enforcement Division’s focus on cyber-related misconduct with the creation of a Cyber Unit and a Retail Strategy Task Force. The Cyber Unit will focus on areas such as (i) market manipulation schemes involving electronically-transferred false information; (ii) data breaches intended to obtain nonpublic information; (iii) distributed ledger technology and initial coin offering violations; (iv) misconduct through the use of the dark web; (v) retail brokerage account intrusions; and (vi) cyber-related threats targeting trading platforms and other critical market infrastructures. The Cyber Unit will complement the SEC’s internal assessment of its cybersecurity risk profile. (See previous InfoBytes coverage here.) The goal of the Retail Strategy Task Force will be to “develop proactive, targeted initiatives to identify misconduct impacting retail investors [and] apply the lessons learned from those cases and leverage data analytics and technology to identify large-scale misconduct affecting retail investors.”
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.”
On August 1, the Federal Reserve Board released a paper on the origins and growth of financial technology, and how these “deep innovations” have the potential to affect financial stability. The paper, “FinTech and Financial Innovation: Drivers and Depth,” was authored by John Schindler and adapted from a speech prepared for Banco Central do Brasil’s XI Annual Seminar on Risk, Financial Stability and Banking. Fintech, according to Schindler’s adaptation of the Financial Stability Board’s definition, is best understood as a “technologically enabled financial innovation that could result in new business models, applications, processes, products, or services with an associated material effect on financial markets and institutions and the provision of financial services.” Schindler considers the following to fall into the definition of fintech: (i) online marketplace lending; (ii) equity crowdfunding; (iii) robo-advice; (iv) financial applications of distributed ledger technology; (v) and financial applications of machine learning (also called artificial intelligence and machine intelligence). The paper provides a deeper discussion into the following topics driving fintech innovation:
- supply and demand factors of financial innovation, including regulatory changes and changes to financial or macroeconomic conditions, contributing to the use of technologies supporting fintech financial products and services;
- depth of innovations such as peer to peer lending, high frequency trading, mobile banking and payments, bitcoin, and blockchain all with the “potential to have transformational effects on the financial system”; and
- demographic demands.
Schindler’s position is that fintech evolved, in large part, due to a combination of a number of supply and demand factors occurring in a relatively small period of time, which, as a result, drove new financial innovations.
On July 25, the SEC issued an investigative report stating that federal securities laws apply to anyone who offers and sells securities in the U.S., regardless of the manner of distribution or whether dollars or virtual currencies are used to purchase the securities. The SEC’s Report of Investigation (Report) advises users to make sure they are compliant with federal securities laws when raising capital through Decentralized Autonomous Organizations (DAO) or other forms of distributed ledgers or blockchain technology. These offering are often referred to as “Initial Coin Offerings” (ICOs) or “Token Sales.”
The Report originates from an Enforcement Division inquiry into whether the DAO—and affiliated entities—“violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for ‘Ether,’ a virtual currency.” According to the SEC, the DAO, which has been described as a “crowdfunding contract,” has not met any of the specific Regulation Crowdfunding exemption requirements issued earlier this year by the agency. These regulations were previously discussed in InfoBytes. In its Report, the SEC stated that the individuals involved in a 2016 virtual currency offering that was later hacked will not face charges, but will rather serve as a warning to the industry that people who offer and sell securities in the U.S. must follow the law. In light of this discussion, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to educate investors about the benefits and risks of ICOs, which promoters have begun to use to sell virtual currencies.
“Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws,” said William Hinman, SEC Director of the Division of Corporation Finance.
BAFT Announces 2017 Global Payments Symposium; Will Highlight Advances in Payments Innovation, Blockchain, and Artificial Intelligence
On July 19 and 20, the Bankers Association for Finance and Trade (BAFT) will host its 2017 Global Payments Symposium in New York City. The symposium will help bankers and payments professionals understand the latest innovation trends affecting compliance, payments, blockchain, fintech, cybercrime, and artificial intelligence, among others. BAFT will also discuss methods to integrate innovations into the business lines and how global challenges and best practices impact the U.S.
- Kathryn L. Ryan and Jedd R. Bellman to discuss “Risk and compliance management: Are you covered?” at a Mortgage Bankers Association webinar
- John R. Coleman to participate in a roundtable on current topics in administrative law at the C. Boyden Gray Center for the Study of the Administrative State at George Mason University
- Melissa Klimkiewicz and Daniel A. Bellovin to discuss “Things to know about flood insurance” at a NAFCU webinar
- Hank Asbill to discuss “Ethical issues at sentencing” at the 31st Annual National Seminar on Federal Sentencing
- Max Bonici will moderate a panel on “Enforcement risk and other regulatory and compliance issues related to crypto and digital assets” at the American Bar Association’s 2022 Annual Meeting
- John R. Coleman to provide a “CFPB Update” at MBA’s 2022 Regulatory Compliance Conference
- Amanda R. Lawrence to discuss “The shifting data privacy and data protection landscape” at MBA’s 2022 Regulatory Compliance Conference
- Jeffrey P. Naimon to provide an “Update on key fair lending cases and the CRA and UDAAP rules” at MBA’s 2022 Regulatory Compliance Conference
- Benjamin W. Hutten to discuss “Fundamentals of financial crime compliance” at the Practicing Law Institute
- Benjamin W. Hutten to discuss “Ongoing CDD: Operational considerations” at NAFCU’s Regulatory Compliance & BSA Seminar
- James C. Chou to discuss ransomware at NAFCU’s Regulatory Compliance & BSA seminar
- Elizabeth E. McGinn, Benjamin W. Hutten, and James C. Chou to discuss “The Evolving Regulatory Landscape: Third-party and cyber risk management” at the 2022 mWISE Conference
- James T. Parkinson to present a “Global anti-corruption update” at IBA’s annual conference