On October 17, 2017, the Commodity Futures Trading Commission (“CFTC”) released a primer on digital currencies, in which it reiterated its position that virtual currencies are commodities.1 The CFTC has taken this position in a number of previous cases, most recently on September 21, 2017 when it charged Gelfman Blueprint, Inc. (“GBI”) and its CEO and head trader (together, the “Defendants”) with operating a virtual currency2 Ponzi scheme, in which the Defendants fraudulently solicited participation in a pooled fund that purportedly employed a high-frequency, algorithmic trading strategy to trade the virtual currency bitcoin, a commodity (the “GBI Enforcement Action”).3 The CFTC alleged that the strategy was fake, the purported performance was false and payouts of supposed profits to investors in actuality consisted of other investors’ funds. In addition, the CFTC alleges that the Defendants misappropriated investor funds to pay business expenses and enrich the CEO and fabricated a hack to explain the loss of its customers’ investments. While previous enforcement actions focused on failures to register under the Commodities Exchange Act (“CEA”),4 this case marks the first CFTC anti-fraud action involving virtual currency. Section 6(c)(1) of the CEA gives the CFTC the power to enforce the provisions of the CEA against persons who employ fraud in connection with the contract of sale of any commodity.
As discussed in a previous memorandum titled “SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities”, the CFTC is not alone in applying its existing regulations to operators of virtual currency investments. The Enforcement Division of the Securities and Exchange Commission (“SEC”) has previously brought charges for failing to register a virtual currency-denominated stock exchange,5 publicly offering the unregistered securities of two companies in exchange for virtual currency,6 and operating a Ponzi scheme in virtual currency.7 The SEC’s recent DAO Report has established that the SEC will treat certain “coins” or “tokens” that are offered through an initial coin offering as a security.8 This means that actions by issuers of virtual currencies and their promoters could be subject to scrutiny by both the SEC and the CFTC for compliance with applicable laws, rules and regulations.
The GBI Enforcement Action highlights the jurisdictional overlap between the CFTC and the SEC in the case of pooled investments in cryptocurrency. Although the enforcement action is the CFTC’s first against an alleged operator of a Ponzi scheme in virtual currency, in 2013 the SEC charged the operator of a virtual currency-denominated investment pool with running a Ponzi scheme (styled SEC v. Shavers, the “Shavers Enforcement Action”).9 SEC enforcement actions have been based on the fact that the interests in the pool were securities and therefore the offer and sale of the security had to be registered, whereas the CFTC’s GBI Enforcement Action focuses on GBI’s alleged fraud in connection with contracts for the sale of a commodity.
Conclusion
The regulation of virtual currencies is a developing area of the law as state and federal agencies seek to balance the need for regulation with the desire not to discourage innovation. Because a variety of state and federal agencies have asserted jurisdiction over virtual currencies, some of which is overlapping, operators of virtual currency investment opportunities should carefully consider whether their activities meet all applicable regulatory requirements.
Seward & Kissel will continue to monitor any developments regarding regulatory treatment of virtual currency. If you have any questions regarding virtual currency or other issues in connection with virtual or cryptocurrencies, please contact one of the attorneys listed below or your Seward & Kissel contact attorney.
For our previous updates and guidance on virtual currency and Initial Coin Offerings prepared by S&K, please refer to the following:
CFTC Considers Virtual Currency Derivatives to be Commodity Interests
SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities
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1 “A CFTC Primer on Virtual Currencies,” released by LabCFTC, the CFTC’s focal point for its efforts to promote responsible FinTech innovation and fair competition for the benefit of the American public.
2 The CFTC defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction.” This definition includes bitcoin.
3 CFTC v. Gelfman et al., No.17-7181 (S.D.N.Y Sept. 21, 2017)
4 The CFTC previously brought actions for operating an unregistered options exchange (In re Coinflip, Inc., CFTC No. 15-29 (Sept. 17, 2015), failing to register as a futures commission merchant and offering certain prohibited off-exchange transactions (In re BFXNA Inc., CFTC No. 16-19 (June 2, 2016), and engaging in illegal wash and prearranged trading (In re TeraExchange LLC, CFTC No. 15-33 (Sept. 24, 2015))
5 In the Matter of BTC Trading Corp. and Ethan Burnside, Securities Act Release No. 9685 (December 8, 2017)
6 In the Matter of Erik T. Voorhees, Securities Act Release No. 9592 (June 3, 2014)
7 SEC v. Shavers, No. 13-416 (E.D. Tex. July 23, 2013)
8 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Act Release No. 81207 (July 25, 2017)
9 SEC v. Shavers, No. 13-416 (E.D. Tex. July 23, 2013)
