The CFTC and SEC made numerous headlines Friday in their ongoing efforts to provide regulatory oversight of cryptocurrency markets. The CFTC announced the filing of two civil enforcement actions against allegedly fraudulent cryptocurrency-related investment schemes. The SEC’s Division of Investment Management, meanwhile, issued a letter raising concerns about registered investment companies’ (including ETFs’) investments in cryptocurrencies and cryptocurrency-related assets. And the SEC and CFTC issued a joint statement emphasizing their collective aim to root out fraud in the offer and sale of digital instruments, regardless of whether such instruments are classified as digital “currency,” “tokens,” or otherwise. (Herein, we refer to this full suite of digital instruments as “cryptocurrencies.”)
CFTC Enforcement Actions
CFTC v. Dillon Michael Dean and The Entrepreneurs Headquarters Limited
The CFTC’s complaint against Dillion Michael Dean and his company The Entrepreneurs Headquarters Limited targets an alleged Ponzi scheme for options fraud, failure to register as a Commodity Pool Operator (“CPO”) and as an Associated Person of a CPO, and CPO fraud.
The CFTC asserts that the Defendants raised about $1.1 million worth of Bitcoin from over 600 publically solicited investors based on representations that customer funds would be pooled and invested by experience professionals in products such as Nadex-traded binary options. Instead, the complaint states the Defendants illegally misappropriated client funds for Ponzi-style payments and personal enrichment, and lied to their customers with respect to their supposed trading and the status of customer accounts.
In addition to sending a strong signal to other would-be fraudulent actors, this proceeding should put any trust, syndicate, or similar business engaged in trading virtual currency derivatives or other commodity interests using pooled investor funds on notice that they may need to register with the CFTC as a CPO.
CFTC v. Patrick K. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets
The CFTC’s complaint against Patrick McDonnell and his company CabbageTech, Corp. asserts that the Defendants fraudulently induced customers to send them funds in exchange for purported virtual currency trading advice and investment and trading services. According to the CFTC, rather than delivering on their various promises and representations, the Defendants simply misappropriated the funds, shut down their websites and ceased communications with their customers.
Both CFTC enforcement actions depend on whether virtual currency is a “commodity” under the Commodity Exchange Act, an issue the CFTC addressed in an earlier order, thereby asserting broad authority over contracts of sale of virtual currencies themselves (as well as derivative contracts on them).
Letter from SEC Division of Investment Management
In response, among other things, to inquiries and applications regarding the listing of cryptocurrency investment funds, the SEC’s Division of Investment Management published a letter to the Investment Company Institute and the Securities Industry and Financial Markets Institute. The SEC letter requests that fund sponsors refrain from initiating (or otherwise withdraw their requests for registration of) funds that invest substantially in cryptocurrency and related products until various questions relating to valuation, liquidity, custody, arbitrage, and the potential for manipulation can be satisfactorily answered.
Joint Statement by SEC and CFTC
SEC Co-Enforcement Directors Stephanie Avakian and Steven Peikin and CFTC Enforcement Director James McDonald issued a joint statement regarding virtual currency enforcement actions. The statement establishes that “the SEC and CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws,” especially as it relates to addressing violations and bringing actions to stop and prevent fraud in the offer and sale of cryptocurrencies.
The fact the two agencies made the statement together is significant, as the division of regulatory responsibility with respect to cryptocurrencies remains unclear. The CFTC appears to view all virtual currencies and derivative contracts on them as subject to its jurisdiction, while the SEC takes a narrower view of its statutory authority. That does not mean that market participants can easily discern which body of laws govern a particular cryptocurrency transaction, however. One CFTC Commissioner Brian Quintenz has suggested that some cryptocurrencies “may actually transform at some point from something that starts off as a security and transforms into a commodity.” Within this context, the joint statement indicates that the SEC and CFTC do not intend to let jurisdictional line-drawing exercises detract from their ability to proceed against fraud on a unified front.
Both CFTC enforcement actions target allegedly fraudulent conduct relating to cryptocurrency investments, evidencing what CFTC Director of Enforcement James McDonnell describes as “the CFTC’s continuing commitment to act aggressively and assertively to root out fraud and bad actors involved in virtual currencies.” Coupled with the SEC and CFTC’s joint statement, this should be the key takeaway from Friday’s activity for cryptocurrency market participants: do not commit fraud and expect to escape unscathed.
Meanwhile, the letter from the SEC’s Division of Investment Management appears designed to slow down (or stop) registered funds’ participation in cryptocurrencies until the SEC becomes more comfortable with the market. In particular, the SEC seems concerned about a potential collapse of cryptocurrency prices or significant fraudulent activities and does not want retail investors to be exposed to either.
UPDATE: On January 24, the CFTC announced yet another cryptocurrency related anti-fraud enforcement action. Here, the CFTC targeted My Big Coin Pay, Inc., along with its agents Randall Crater and Mark Gillespie, for allegedly making materially misleading statements in connection with the offer and sale of a “fully functioning” virtual currency called My Big Coin (“MBC”), and misappropriating customer funds for Ponzi-style payments and personal enrichment. Together with the filing of its complaint, the CFTC sought and obtained a preliminary injunction to freeze the assets of the defendants (and relief defendants, who received proceeds from MBC customers).
As noted above, the CFTC’s jurisdiction is predicated on its position that “virtual currencies” constitute commodities. The present action demonstrates that the CFTC views this virtual currency category as containing not just Bitcoin, or Litecoin, but also obscure tokens with questionable purchasing power such as MBC.