InfoBytes Blog
Filter
Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.
Russia Weighs Risks of Cryptocurrencies; President Putin Seeks Regulations
On October 10, the First Deputy Governor of Russia’s Central Bank reportedly announced plans to block websites selling bitcoin and other forms of cryptocurrency. Citing unreasonably high risks and the need to protect investors from the “dubious” currencies, the Central Bank’s concerns were echoed by President Vladimir Putin who reportedly stressed that risks associated with the use of cryptocurrencies include money laundering, tax evasion and funding for terrorism. However, President Putin issued a call for cryptocurrency regulation rather than a broad ban and stressed the need to utilize international experience when establishing rules.
Last September, as previously reported in InfoBytes, several Chinese regulators reportedly announced plans to ban the commercial trading of bitcoin and other cryptocurrencies in the country.
SEC Announces Two Enforcement Initiatives Designed to Combat Cyber Threats
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.”
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.”
SEC Issues Investor Bulletin Concerning Fraud Related to Initial Coin Offerings
On August 28, the SEC Office of Investor Education and Advocacy (OIEA) released an Investor Bulletin about the risks associated with investing in companies that claim to be related to, or assert that they are engaged in, Initial Coin Offerings (ICOs). ICOs are also known as coin or token launches, and sales are often used to raise capital. However, the OIEA warns investors that while some companies employ ICOs for lawful opportunities, the agency is cracking down on companies who use emerging technologies like ICOs for fraudulent purposes, such as announcing ICOs in order to affect the price of their common stock. The OIEA issued guidance, including (but not limited to) the following, to help investors spot potential fraud:
- Investors should consider past trading suspensions as warning signs of possible microcap fraud when considering whether to invest, especially if there is a lack of current, reliable information about the company and its stock offerings.
- Investors should be cautious about “pump-and-dump” schemes where companies manipulate the price of a stock to urge investors to buy quickly through false and misleading statements, and then unload shares of those stocks at artificially inflated prices, causing investors to lose money.
- Investors should understand the risks of investing with companies that are not required to file reports with the SEC (“non-reporting companies”);
- Investors should be very cautious of stock promotions offered by companies that do not provide details on whether the ICOs are compliant with securities law.
The bulletin also includes links to additional investor resources, including an Investor Bulletin on ICOs.
Federal Reserve Releases Paper Studying the Evolution and Forward Looking Growth of Fintech
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.
SEC Issues Investigative Report: Federal Securities Laws Apply to Virtual Organizations
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.
House Subcommittee on Digital Commerce and Consumer Protection Holds Hearing to Discuss Consumer Fintech Needs
On June 8, the House Energy and Commerce Committee’s Subcommittee on Digital Commerce and Consumer Protection held a hearing to discuss financial products and services offered by the fintech industry to meet consumer needs. (See previous InfoBytes coverage here.) Committee Chairman Rep. Bob Latta (R-Ohio) opened the hearing asserting, “There are serious opportunities for companies to reach consumers with new products to help them create a rainy-day fund for the first time, pay their mortgage securely, rebuild their credit, budget and manage multiple income streams, and invest their earnings . . . Cybersecurity [specifically] is an ongoing challenge, and one the Energy and Commerce Committee is tackling head on.” The June 8 hearing included testimony and recommendations from the following witnesses:
- Ms. Jeanne Hogarth, Vice President at Center for Financial Services Innovation (CFSI) (statement). Hogarth stated that nearly three out of five American face financial health struggles and spoke about challenges fintech entrepreneurs may face when trying to help consumers, such as (i) “facilitat[ing] interstate and regulatory comity that enables consumers to access and use fintech products and service that promote financial health”; (ii) “support[ing] consumers’ access to their own data”; and (iii) “creat[ing] opportunities for pilot testing of both financial products and services and financial services regulations.” Hogath also detailed CFSI’s Financial Solutions Lab, which identifies financial health challenges faced by consumers and encourages companies to develop ways to address these issues.
- Mr. Javier Saade, Managing Director at Fenway Summer Ventures (statement). Saade—whose venture capital firm backs emerging fintech companies—stressed the importance of understanding and mitigating associated risks as financial innovation continues to expand. Growth is supported and encouraged, he noted, provided entrepreneurs understand that the “’fail fast and often’ approach, typical of tech-driven startups in other sectors, may not be well suited for the financial services industry.” Furthermore, Saade stated that because “nearly 30 million U.S. households either have no access to financial products or obtain products outside of the banking system . . . even modest strides in achieving economic inclusion present the single largest addressable opportunity in fintech.”
- Ms. Christina Tetreault, Staff Attorney at Consumer Union (statement). Tetreault, speaking on behalf of Consumer Union (the policy division of Consumer Reports), stated that while financial technology such as virtual currencies, digital cash, and distributed ledgers have the “potential to increase consumer access to safe financial products and return a measure of control to consumers,” safeguards devised between lawmakers and providers must be implemented with appropriate federal and state financial regulator oversight.
- Mr. Peter Van Valkenburgh, Research Director at Coin Center (statement). Coin Center is a non-profit organization, which focuses on “public policy ramifications of digital currencies and open blockchain networks.” Van Valkenburgh emphasized the need for Congress to (i) create a nationwide federal money transmission license as an alternative to “state by state licensing,” which, in his opinion, emphasizes the needs of individual states rather than addressing the health and risk profile as a whole; and (ii) create a federal safe harbor to “protect Americans developing open blockchain infrastructure.” Van Valkenburgh also encouraged the Office of the Comptroller of the Currency to establish federal “fintech charters” to promote a unified approach to regulating blockchain companies.
FINRA Announces Fintech Outreach Initiative, Hosts Blockchain Symposium in July
On June 13, the Financial Industry Regulatory Authority (FINRA) announced a new outreach initiative to improve its understanding of fintech innovations and how they impact the securities industry. The Innovation Outreach Initiative will consist of the following components:
- the launch of FINRA’s new webpage dedicated to fintech topics such as RegTech (covering compliance monitoring, fraud prevention, data management, and the identification and interpretation of regulations affecting the securities industry), artificial intelligence, and social media sentiment investing; and
- the creation of a cross-departmental team led by the Office of Emerging Regulatory Issues developed to, among other things, foster discussion on fintech developments, develop publications on fintech topics, and increase collaboration with domestic and international regulators.
Additionally, FINRA announced it will host a Blockchain Symposium in New York City on July 13 to create an opportunity for regulators and industry leaders to join together and discuss opportunities and challenges related to the use of Distributed Ledger Technology, also known as blockchain.