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SEC Settles with New York Financial Firm and Employee Over Alleged Failure to Protect Customer Data
On June 8, the SEC announced that a New York-based financial services firm agreed to pay a $1 million civil monetary penalty to resolve allegations that it violated the “Safeguards Rule,” Rule 30(a) of Regulation S-P (17 C.F.R. § 248.30(a)). According to the SEC, the firm “failed to ensure the reasonable design and proper operation of its policies and procedures in safeguarding confidential customer data.” The SEC further contends that the firm failed to audit or test the authorization models that allowed employees to access the portals hosting customer data. The financial services firm settled the charges without admitting or denying the SEC’s findings. As of result of the company’s alleged failures, between 2011 and 2014, a then-current employee of the firm gained access to and copied data regarding approximately 730,000 customer accounts to his personal server. The SEC alleges that the employee’s personal server was hacked, and portions of the misappropriated data were posted to at least three Internet sites, with an offer to sell more of the stolen data in exchange for payment in digital currency. Per the employee’s separate consent order, the employee agreed to an industry and penny stock bar with the right to apply for reentry after five years. He was previously criminally convicted for his actions and received 36 months of probation and $600,000 in restitution.
DOJ Sentences Founder of Money Laundering Operation to 20 Years Imprisonment
On May 6, the DOJ announced that U.S. District Judge Denise L. Cote sentenced the founder of a Costa Rica-based virtual currency company to 20 years imprisonment and ordered him to pay a $500,000 fine for charges related to illegal money laundering. According to the DOJ, the individual owner, at all relevant times, directed and supervised the company’s operations and was aware that cybercriminals, such as credit card traffickers and identity thieves, were using the “digital currency empire” to launder the proceeds of illegal activity. The DOJ further asserts that the company “grew into a financial hub for cybercriminals around the world, trafficking the criminal proceeds of Ponzi schemes, credit card trafficking, stolen identity information and computer hacking.” When the government shut the company down in May 2013, it had more than 5.5 million user accounts worldwide and more than 78 million financial transactions processed, valued at more than $8 billion. Prior to the sentencing hearing, the owner pleaded guilty to one count of conspiring to commit money laundering; four other co-defendants also pleaded guilty, with two individuals being sentenced to five and three years in prison and two others awaiting sentencing.
Georgia Department of Banking and Finance Authorized to Enact Money Transmission Regulations
On April 26, Georgia Governor Nathan Deal signed into law HB 811, an Act to amend Title 7 of the Official Code of Georgia Annotated, which includes banking and finance provisions. Notably, the Act authorizes the Georgia Department of Banking and Finance to enact rules and regulations to apply to persons engaged in money transmission or the sale of payment instruments involving virtual currency, as it finds necessary to, among other things, ensure the continued solvency, safety, soundness, and prudent conduct of persons engaged in those businesses, protect customers, encourage high standards of honesty, transparency, fair business practices and public responsibility, and provide customers with timely and understandable information about virtual currency products and services. The Act is effective July 1, 2016.
FinCEN Announces Departure of Director Calvery
On April 26, FinCEN announced the departure of Director Calvery. Commenting on Calvery’s accomplishments during her tenure as Director, the agency opined that, “[u]nder Ms. Calvery’s direction, [it] has enhanced its reputation within the U.S. government, throughout the U.S. financial sector, and with international financial partners as a key resource in the fight against terrorist finance, money laundering, and transnational organized crime.” As Director of FinCEN since September 2012, Calvery’s team has addressed topics such as virtual currency, money laundering via real estate purchases, and terrorist financing. Calvery will be departing FinCEN at the end of May 2016.
Digital Insights & Trends: Clearing and Settlement Platforms to Watch in 2016
2015 was the year that blockchain technology, initially used as the public ledger for tracking bitcoin, began to mature and expand beyond payments. While regulators focused on the risks associated with virtual currency, technology companies and financial institutions forged ahead with developing alternate uses for the blockchain.Using blockchain technology offers many upsides, with one of the most notable being faster clearing and settlement functionality. Companies that can clear and settle transactions faster and at a reduced cost will have a competitive advantage. Thus far, however, no dominant player has emerged.
There are a number of companies that are working on creating blockchain platforms for financial institutions to use to clear and settle trades. Below are just a few of note:
- Digital Asset Holdings. Blythe Master and team are developing a blockchain platform for financial institutions to use to settle digital currency trades as well as digitized versions of financial assets. Digital Asset Holdings recently purchased Hyperledger, which developed a distributed ledger to allow banks and other financial institutions to clear and settle transactions in real time, and Blockstack, which offers private blockchain services.
- Ethereum. Launched in mid-2015, it offers its own decentralized blockchain platform that allows each blockchain to be customized to fit the specific security that is subject to clearance and settlement.
- Bankchain. Developed by ItBit, it is a ledger system seeking to leverage the blockchain for clearing, settlement, and custody.
- Clearmatics is working with UBS to help develop a digital coin based on blockchain technology to settle trades and make cross-border payments.
- R3CEV has developed a consortium of 42 banks dedicated to developing blockchain technology for settlements and payments, among other things.
- Citigroup is developing various blockchain technologies (at least three) and has created a test virtual currency, “Citicoin,” which it uses to test the blockchain technologies.
In addition, companies are using blockchain technology to issue and trade equities. At the end of 2015, Nasdaq issued shares in Chain.com using Nasdaq Linq, its blockchain ledger technology. Additionally, the SEC approved Overstock.com’s plan to issue company stock via blockchain through its subsidiary, t0.
As the above demonstrates, both technology companies and financial institutions will be focused on developing numerous use cases for blockchain technology beyond payments in 2016. Regulators are also beginning to focus on the blockchain technology itself as opposed to solely virtual currency. For example, the CFTC is holding a hearing on January 26, 2016 to discuss the use of blockchain technology in derivatives markets. Taken together, 2016 seems to be the year that blockchain technology separates itself from payments and begins to stand on its own. Judging by the CFTC’s interest in blockchain technology, it appears that regulators may be thinking the same thing.
For another retrospective on the blockchain in 2015, see our Coindesk article "The Stories That Shaped the Blockchain Narrative in 2015."
DOJ Announces Sentencing of Former Secret Service Agent for Involvement in Silk Road Investigation
On December 7, the DOJ announced that a former Secret Service agent was sentenced to 71 months in prison on charges of money laundering and obstruction of justice. Between 2012 and 2014, the former agent conducted forensic computer investigations from the Northern District of California to locate, identify, and prosecute persons involved in operating Silk Road, a covert online marketplace for illicit goods, as part of the Baltimore Silk Road Task Force. As part of his guilty plea, the agent admitted to using account information from a January 2013 search and arrest of a Silk Road customer support representative to “reset passwords and pins of various accounts on Silk Road and move approximately 20,000 bitcoin, at the time worth approximately $350,000, from those accounts into a bitcoin ‘wallet’ [he] controlled.” The former agent also admitted to (i) moving stolen bitcoin money into an account on a Japan-based online digital currency exchange; (ii) liquidating the bitcoin into $820,000 in U.S. currency and transferring those funds into a personal investment account in the U.S.; (iii) using the customer support representative’s access to Silk Road to steal bitcoin, which limited the investigation of Silk Road; and (iv) making false and misleading statements to both prosecutors and investigators involved in the San Francisco grand jury investigation into his activity. In addition to the prison sentence, the court ordered the former agent to forfeit more than $650,000. The Secret Service agent is the second federal agent to be sentenced this year in connection with the Baltimore Silk Road Task Force’s investigation into the Silk Road.
SEC Files Complaint Against Bitcoin Mining Companies for Running Alleged Ponzi Scheme
On December 1, the SEC announced that it charged two Connecticut-based Bitcoin mining companies and their founder with allegedly running a Ponzi scheme, from approximately August 2014 through December 2014, to defraud investors by purportedly offering shares of a digital Bitcoin mining operation. The companies offered shares in mining profits via investment contracts called “Hashlets,” which entitled the investor to a portion of the profits from the defendants’ calculated “hashing power.” The SEC’s complaint alleges that the “defendants sold far more Hashlets worth of computing power than they actually had in their computer centers,” and that the investors ultimately paid for a share of “hashing power” that did not exist. The SEC further alleged that the defendants misrepresented to investors the potential of their virtual currency mining operations by making false statements about the profitability and life-span of Hashlets and how the payouts for Hashlets were derived, among other things. The defendants earned approximately $19 million in revenue from selling Hashlets to more than 10,000 investors. The SEC’s complaint seeks permanent injunctive relief and the disgorgement of the defendants’ ill-gotten gains, plus pre-judgment interest.
DOJ Announces Sentencing of Former DEA Agent for Criminal Involvement in Silk Road Investigation
On October 19, the DOJ announced that a former DEA agent was sentenced to 78 months in prison for crimes he committed while working as an undercover agent in the Silk Road investigation. On July 1, the former DEA agent pleaded guilty to charges of extortion, money laundering, and obstruction of justice. Using his DEA-sanctioned persona, “Nob,” the former agent sold Ross Ulbricht – Silk Road’s convicted operator – fake drivers’ licenses and inside information about the investigation, directing Ulbricht to conceal his payments, which were made in bitcoin, using encrypted messaging. Understanding that the payments were government property and constituted evidence of a crime, the former agent admitted to falsifying reports and depositing the funds into his own personal bank accounts, receiving more than $100,000 in bitcoin payments from Ulbricht. In addition, the former agent created another, not government-sanctioned online persona, “French Maid,” which he used to solicit and receive approximately $100,000 in bitcoins from Ulbricht in exchange for information on the government’s Silk Road investigation. The former agent also admitted to serving as the chief compliance officer for a digital currency exchange company, even though he did not receive permission from the DEA to do so. In February 2014, the company alerted him to suspicious activity in a certain account, but, using his capacity as a DEA agent, the former agent directed the company to freeze $337,000 in cash and digital currency from the account, and then transferred $300,000 of the digital currency into an account he controlled. In addition to his prison sentence and post-sentence supervision, the former DEA agent will pay $340,000 in restitution.
NYDFS Approves Virtual Currency Firm's Application: First Company to Receive BitLicense
On September 22, NYDFS Acting Superintendent Anthony Albanese announced that the New York Department of Financial Services (NYDFS) granted its first BitLicense from its current applicant pool. In June 2015, the NYDFS finalized the BitLicense framework, requiring existing virtual currency companies to apply by August 10. Via blog post, the first licensee acknowledged receiving the license. To date, the NYDFS has received 25 BitLicense applications and, according to Albanese, “will continue to move forward on evaluating and approving additional BitLicenses.”
CFTC Issues Cease and Desist Order to Unregistered Bitcoin Options Trading Platform, States Bitcoin and Other Virtual Currencies are Commodities
On September 17, the Commodity Futures Trading Commission (CFTC) issued an Order against an unregistered San Francisco-based bitcoin options trading platform and its CEO for alleged violations of the Commodity Exchange Act (CEA) and CFTC Regulations. According to the Order, from March 2014 to at least August 2014, the company and its CEO operated an online website that allowed for the trading or processing of swaps between buyers and sellers of bitcoin options contracts. For the first time, bitcoin and other virtual currencies “are encompassed in the definition and properly defined as commodities,” making them subject to the same regulations as options or swaps. According to the CFTC, the company operated without being properly registered as a swap execution facility or designated contract market, violating the CEA and CFTC regulations. The CFTC’s Director of Enforcement Aitan Goelman noted, “While there is a lot of excitement surrounding Bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.” The Order did not impose any monetary sanctions on the company, but required the company to cease and desist any action violating the CEA and CFTC regulations and to cooperate in future investigations conducted by the CFTC or other governmental agencies.
