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Arizona approves two more participants in fintech sandbox program
On November 1, the Arizona Attorney General announced the approval of two more participants in the state’s fintech sandbox program. The first company, which is based in New York, will test a savings and credit product, enabling Arizona consumers to obtain a small line of credit aimed at providing overdraft protection. If a consumer agrees to a repayment plan recommended by the company’s proprietary technology, the APR may be as low at 12 percent; if a consumer adopts a different repayment plan, the line of credit will have a standard APR of 15.99 percent. The company intends to report transactions under the payment plan to national credit bureaus to enable the building of credit histories. The second company, an Arizona-based non-profit, will test a lending product using proprietary blockchain technology, which has an APR cap of 20 percent.
As previously covered by InfoBytes, the Arizona governor signed legislation in March creating the first state sandbox program for companies to test innovative financial products or services without certain regulatory requirements. In October, the Attorney General announced the first sandbox participant, a mobile platform company (InfoBytes coverage available here).
FATF updates standards to prevent misuse of virtual assets; reviews progress on jurisdictions with AML/CFT deficiencies
On October 19, the Financial Action Task Force (FATF) issued a statement urging all countries to take measures to prevent virtual assets and cryptocurrencies from being used to finance crime and terrorism. FATF updated The FATF Recommendations to add new definitions for “virtual assets” and “virtual asset service providers” and to clarify how the recommendations apply to financial activities involving virtual assets and cryptocurrencies. FATF also stated that virtual asset service providers are subject to Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regulations, which require conducting customer due diligence, such as ongoing monitoring, record-keeping, and suspicious transaction reporting, and commented that virtual asset service providers should be licensed or registered and will be subject to compliance monitoring. However, FATF noted that its recommendations “require monitoring or supervision only for purposes of AML/CFT, and do not imply that virtual asset service providers are (or should be) subject to stability or consumer/investor protection safeguards.”
The same day, FATF announced that several countries made “high-level political commitment[s]” to address AML/CFT strategic deficiencies through action plans developed to strengthen compliance with FATF standards. These jurisdictions are the Bahamas, Botswana, Ethiopia, Ghana, Pakistan, Serbia, Sri Lanka, Syria, Trinidad and Tobago, Tunisia, and Yemen. FATF also issued a public statement calling for continued counter-measures against the Democratic People's Republic of Korea due to significant AML/CFT deficiencies and the threats posed to the integrity of the international financial system, and enhanced due diligence measures with respect to Iran. However, FATF will continue its suspension of counter-measures due to Iran’s political commitment to address its strategic AML/CFT deficiencies.
SEC launches FinHub to facilitate fintech innovation
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.
Financial Stability Board report: Crypto-assets not yet posing material risk to financial stability
On October 10, the Financial Stability Board (FSB) published a report, which asserts that although “crypto-assets do not pose a material risk to global financial stability at this time,” there may be implications for financial stability in the future as market developments evolve. The newest report, “Crypto-asset markets: Potential channels for future financial stability implications,” follows a July report discussing the FSB’s framework for monitoring and assessing vulnerabilities in the financial system resulting from developments in the crypto-asset markets. (See previous InfoBytes coverage here.) According to the October report, the FSB conducted an assessment which considered the primary risks present in crypto-assets and their markets, such as “low liquidity, the use of leverage, market risks from volatility, and operational risks,” and determined that, “[b]ased on these features, crypto-assets lack the key attributes of sovereign currencies and do not serve as a common means of payment, a stable store of value, or a mainstream unit of account.” However, the October report discussed challenges to assessing and monitoring potential risks and commented on the following implications that may arise from the evolving use of crypto-assets: (i) reputational risks to financial institutions and their regulators; (ii) risks from direct or indirect exposures of financial institutions; (iii) risks resulting from the use of crypto-assets in payments and settlements; and (iv) risks from market capitalization and wealth effects.
California to appoint “blockchain” working group
On September 28, the California governor signed AB 2658, which requires the Secretary of the Government Operations Agency to appoint a blockchain working group by July 1, 2019. (The act defines blockchain as “a mathematically secured, chronological, and decentralized ledger or database.”) The working group is charged with evaluating, among other things, (i) the risks and benefits associated with the use of blockchain by state government and California-based businesses; (ii) the legal implications of the use of blockchain; and (iv) best practices for enabling blockchain technology to benefit the state and its businesses and residents. The act, which has a sunset date of January 1, 2022, requires the working group to provide a report to the legislature by July 1, 2020.
Colorado regulator exempts certain cryptocurrency exchanges from money transmitter licensing requirements
On September 20, the Colorado Department of Regulatory Agencies Division of Banking (Division) issued interim guidance exempting certain types of cryptocurrency exchanges from the state’s money transmitter licensing requirements. Under the interim guidance—which outlines the Division’s interpretation of Colorado’s existing Money Transmitters Act (the Act)— the Division determined that the Act regulates the transmission of money, meaning legal tender, and that cryptocurrencies are not legal tender under the Act. As a result, virtual currency exchanges operating in Colorado do not require a license if transmitting only cryptocurrencies without any legal tender issued and backed by a government (fiat currency) involved in the transaction. However, if fiat currency is present in a transaction, then a virtual currency exchange may require a license. Additionally, a virtual currency exchange must obtain a license when it performs all of the following: (i) it engages in the business of selling and buying cryptocurrencies for fiat currency; (ii) it allows a Colorado customer to transfer cryptocurrency to another customer within the exchange; and (iii) it allows the transfer of fiat currency through the medium of cryptocurrency within the exchange. If a virtual currency exchange offers the ability to transfer fiat currency through the medium of cryptocurrency, the Division encourages the exchange to contact the Division to determine whether it must obtain a license.
New York Attorney General issues Virtual Markets Integrity Report, following cryptocurrency integrity initiative
On September 18, the New York Attorney General’s office announced the results of its Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or “crypto” currencies. As previously covered in InfoBytes, last April questionnaires were sent to 13 virtual asset trading platforms to solicit information on their operations, policies, internal controls, and safeguards to protect consumer assets. The resulting Virtual Markets Integrity Report finds that virtual asset trading platforms vary significantly in the comprehensiveness of their response to the risks facing the virtual markets, and presents three broad areas of concern: (i) the potential for conflicts of interest due to platforms engaging in various overlapping business lines that are not restricted or monitored in the same way as traditional trading environments; (ii) a lack of protection from abusive trading platforms and practices; and (iii) limited protections for customer funds, such as the insufficient availability of insurance for virtual asset losses and platforms that do not conduct any type of independent auditing of virtual assets. According to the report, the Attorney General’s office also referred three platforms to the New York Department of Financial Services for potential violations of the state’s virtual currency regulations.
District court rules U.S. securities law may cover initial coin offering in criminal case
On September 11, the U.S. District Court for the Eastern District of New York issued a ruling that the U.S. government can proceed with a case for purposes of federal criminal law against a New York-based businessman who allegedly made “materially false and fraudulent representations and omissions” connected to virtual currencies/digital tokens backed by investments in real estate and diamonds sold through associated initial coin offerings (ICOs). The defendant—who was charged with conspiracy and two counts of securities fraud for his role in allegedly defrauding investors in two ICOs—claimed that the ICOs at issue were not securities but rather currencies, and that U.S. securities law was unconstitutionally vague as applied to ICOs. However, the U.S. government asserted that the investments made in the tokens were “investment contracts” and thereby “securities” as defined by the Securities Exchange Act. The U.S. government further argued that the jury should apply the central test used by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine if a financial instrument “constitutes an ‘investment contract’ under the federal securities laws.” The judge commented that “simply labeling an investment opportunity as ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract—a security—into a currency.” Moreover, while the judge cautioned that it was too early to determine whether the virtual currencies sold in the ICOs were covered by U.S. securities law, he concluded that a “reasonable jury” may find that the allegations in the indictment support such a finding.
CFTC wins $1.1 million judgment in cryptocurrency fraud action
On August 23, the U.S. District Court for the Eastern District of New York entered final judgment in favor of the Commodity Futures Trading Commission (CFTC) in its suit against a cryptocurrency trading advice company and its owner (defendants) for allegedly misappropriating investor money through a cryptocurrency trading scam. As previously covered by InfoBytes in March, the court granted the CFTC’s request for a preliminary injunction, holding that the CFTC has the authority to regulate virtual currency as a “commodity” within the meaning of the Commodity Exchange Act and that the CFTC has jurisdiction to pursue fraudulent activities involving virtual currency even if the fraud does not directly involve the sale of futures or derivative contracts. The final judgment orders the defendants to pay over $1.1 million in restitution and civil money penalties and permanently enjoins them from engaging in future activities related to commodity interests and virtual currencies.
FinCEN director discusses approach to virtual currency and emerging technology
On August 9, Financial Crimes Enforcement Network (FinCEN) Director Kenneth A. Blanco delivered remarks at the 2018 Chicago-Kent Block (Legal) Tech Conference to discuss, among other things, the agency’s approach to virtual currency and its efforts to protect financial institutions from being exploited for illicit financing purposes as new financial technologies evolve and are adopted. Blanco commented that while innovation provides customers with greater access to financial services, it can also create opportunities for criminals or serve as a vehicle for fraud. Blanco discussed several areas of focus, such as (i) the regulation of virtual currency and initial coin offerings (ICOs), along with coordinated policy development and regulatory approaches done in conjunction with the SEC and CFTC; (ii) examination and supervision efforts designed to “proactively mitigate potential illicit finance risks associated with virtual currency”; (iii) anti-money laundering/countering the financing of terrorism (AML/CFT) regulatory compliance expectations for companies involved in ICOs or virtual currency transmissions; (iv) enforcement actions taken against companies that fail to implement effective programs; (v) the rise and importance of virtual currency suspicious activity report filings which help the agency identify and investigate illicit activity; and (vi) the development of an information sharing virtual currency-focused FinCEN Exchange program. Blanco emphasized that “individuals and entities engaged in the business of accepting and transmitting physical currency or convertible virtual currency from one person to another or to another location are money transmitters subject to the requirements” of the Bank Secrecy Act.