Representing Parties in Federal and State Cryptocurrency Investigations - PowerPoint Presentation

Representing Parties in Federal and State Cryptocurrency Investigations Sidley Austin llp October 11, 2018

TABLE OF CONTENTS Range of Investigations – CFTC, NFA and Futures Exchanges 3The Range of Investigations – SEC and FINRA Investigations 5The Range of Investigations – Department of Justice 6The Range of Investigations – State Securities Regulators, Including the NY Department of Financial Services 7The Range of Investigations – Jurisdiction, Parallel, Cross-border, Industry Sweeps 8Types of Representations – CTAs, CPOs, FCMs 10Types of Representations – Exchanges 11Types of Representations – Cryptocurrency Promotors and Platforms 12Cryptocurrency Conduct Issues – Fraud 13Cryptocurrency Conduct Issues – Ponzi Schemes 15Cryptocurrency Conduct Issues – Retail Customer Abuse 17Cryptocurrency Conduct Issues – Manipulation 18Cryptocurrency Conduct Issues – Insider Trading 19 2

THE RANGE OF INVESTIGATIONS - CFTC, NFA AND FUTURES EXCHANGES CFTCCFTC has the authority to investigate and civilly prosecute violative activities involving cryptocurrency derivatives.Under CFTC Rule 180.1, CFTC also has the authority to investigate and civilly prosecute manipulative, fraudulent or deceitful activity in connection with any contract of sale of any commodity in interstate commerce, i.e., non-derivatives transactions involving cryptocurrencies. CFTC’s Staff Advisory No. 18-14 (May 21, 2018), Advisory With Respect to Virtual Currency Derivative Product Listings.Enhanced market surveillance by the Division of Enforcement Coordination with the CFTC’s surveillance teamExchanges to provide trade data and information about the underlying spot markets that comprise the cash settlement priceReal-time monitoring for manipulative trading, disorderly trading and system anomaliesEncourages inter-exchange information-sharing arrangements that provide access to trade data on underlying spot markets In May 2018, the CFTC reportedly subpoenaed four cryptocurrency exchanges -- Coinbase, Kraken, itBit, and Bitstamp -- for “comprehensive trading data” to assist a probe into whether manipulation is distorting prices of bitcoin futures. U.S. Regulator Demands Trading Data From Bitcoin Exchanges in Manipulation Probe, Wall Street Journal (June 8, 2018).CFTC and the DOJ are reportedly investigating criminal manipulative activity involving bitcoin and ether spot and futures trading, including spoofing and wash trading. “U.S. Launches Criminal Probe into Bitcoin Price Manipulation,” Bloomberg (May 24, 2018). Reportedly, the joint investigation has also reached outside the U.S., U.K. traders and other non-U.S. traders. Bitcoin Investigation to Focus on British Traders, The Times (May 25, 2018).NFAAs a self-regulatory organization, the NFA can investigate and bring membership disciplinary actions against NFA members, but has no jurisdiction over non-members.NFA Notice 1-17-27 (December 6, 2017), Additional Reporting Requirements Regarding Virtual Currency Futures Products for FCMs for Which NFA is the DSRO.FCMs must immediately notify NFA if the FCM decides to offer its customers or non-customers the ability to trade any virtual currency futures productSimilar NFA Notice 1-17-29 for IBs. 3

THE RANGE OF INVESTIGATIONS - CFTC, NFA AND FUTURES (CONT’D) NFA Notice 1-17-28 (December 14, 2017), Additional Reporting Requirements for CPOs and CTAs that Trade Virtual Currency Products.Must immediately notify NFA by amending the firm-level section of its annual questionnaire if it executes any virtual currency or virtual currency derivative on behalf of a pool or managed account and when it begins trading these products.NFA Bylaw 1101 provides that “No Member may carry an account, accept an order or handle a transaction in commodity futures contracts for or on behalf of any non-Member of NFA, or suspended Member, that is required to be registered with the Commission as an FCM, IB, CPO, CTA or LTM, and that is acting in respect to the account, order or transaction for a customer, a commodity pool or participant therein, a client of a commodity trading advisor, or any other person… ” NFA will examine any NFA member who does any business with a virtual currency investment fund, customer, platform or adviser to determine whether NFA Bylaw 1101 has been complied with and the good faith procedures the member implemented to assure compliance. Futures ExchangesChicago Mercantile Exchange and the Chicago Board Options Exchange are CFTC-regulated designated contract markets for the trading of Bitcoin futures contracts. To be listed on a designated contract market, DCM Core Principal 3 requires that the futures contract is “not readily susceptible to manipulation.” CME has entered into information-sharing agreements with the unregulated cryptocurrency exchanges that form the basis for the reference rate for the CME Bitcoin futures contract, allowing CME to obtain data and information regarding the underlying spot market in order to conduct robust surveillance and investigations regarding the trading of their Bitcoin futures contract.The major regulated designated contract markets on which cryptocurrency futures are traded have rules that permit them to investigate and bring disciplinary actions against their members as well as non-members who trade on the exchange. Their rules provide that trading on the exchange constitutes a submission to the exchange’s jurisdiction. Important Takeaways CFTC has the authority to investigate and bring enforcement actions involving fraud or manipulation in spot, cash and forward virtual currency transactions, they do not have to be derivatives. NFA is keeping a close eye on the virtual currency activities of CFTC registrants.Futures exchanges have enhanced market surveillance efforts involving the virtual currencies that underlay their futures contracts.4

THE RANGE OF INVESTIGATIONS - SEC AND FINRA INVESTIGATIONS ICOsSection 5 of the Securities ActSection 10(b) of the Exchange ActIIlegal sales of blockchain-related stocksSection 5 of the Securities ActTrading SuspensionsSection 12(k) of the Exchange ActSupervision, compliance and operational infrastructure at BDsVarious statutory, regulatory provisions and FINRA rulesExchangesNo cases yet, but statement by SEC Director in June that “We’re underwhelmed by the enthusiasm for coming within the regulatory structure right now.” Important Takeaways Broad interest by the securities regulators. Tip of the iceberg.Intermediaries as well as issuers.5

THE RANGE OF INVESTIGATIONS - DEPARTMENT OF JUSTICE Money Laundering18 U.S.C. §§ 1956 and 1957United States v. BTC-e & Alexander Vinnik (N.D. Cal.): Digital currency exchange indicted for allowing itself to be used as platform ““to facilitate transactions for cybercriminals worldwide and [to] receive[] the criminal proceeds of numerous computer intrusions and hacking incidents, ransomware scams, identity theft schemes, corrupt public officials, and narcotics distribution rings.”United States v. Netyksho, et al. (D.D.C.): 12 Russian intelligence officers charged with hacking the 2016 presidential election alleged to have “transferr[ed] cryptocurrencies through a web of transactions in order to purchase computer servers, register domains, and make other payments in furtherance of their hacking activities, while trying to conceal their identities and their links to the Russian government.” Investor FraudWire and Mail Fraud: 18 U.S.C. §§ 1341 and 1343Securities Fraud: Section 10(b) of the Exchange Act, 15 U.S.C. § 78(j)Market ManipulationSecurities Fraud: Section 10(b) of the Exchange Act, 15 U.S.C. § 78(j) Miscellaneous Crimes Income Tax Evasion: 26 U.S.C. § 7201 Interstate Transportation of “stolen goods, securities, moneys”: 18 U.S.C. § 2314 Important TakeawayCryptocurrency can be the object of, or the means to facilitate, nearly any crime that could already have been committed for or with currency or other securities.6

THE RANGE OF INVESTIGATIONS - STATE SECURITIES REGULATORS, INCLUDING THE NY DEPARTMENT OF FINANCIAL SERVICES 200 active investigations of Initial Coin Offerings (ICOs) and cryptocurrency-related investment products currently underway by state and provincial securities regulators in the United States and Canada46 enforcement actions since May 2018Fail to RegisterFraudOn September 18, 2018, the Office of the New York Attorney General issued the Virtual Markets Integrity Report concerning the policies and practices of cryptocurrency trading platforms. Among the conclusions, the Attorney General found that some of these trading platforms may (1) engage in several lines of business involving simultaneously serving as exchanges, broker-dealers, money-transmitters, owners of cryptocurrency holdings, and in some cases as issuers of cryptocurrencies, that may pose conflicts of interest with their customers; (2) have not implemented serious efforts to impede abusive trading activity; and (3) have limited protection for customer positions. The Attorney General referred three platforms to the NY Department of Financial Services to determine if they are operating unlawfully in NY.Important TakeawaysNew York’s Department of Financial Services is an aggressive financial investigator and enforcer. In any cryptocurrency investigation, it is a reasonable assumption that state and federal regulators are sharing information and coordinating their enforcement activities. Having even one customer in a given state will subject a cryptocurrency platform, dealer or adviser to the potential scrutiny of the state’s securities regulator and attorney general. 7

THE RANGE OF INVESTIGATIONS - JURISDICTION, PARALLEL, CROSS-BORDER, INDUSTRY SWEEPS CFTC Jurisdictional InvestigationsCFTC has delegated to the CFTC’s Division of Enforcement the authority to request voluntary statements and submissions to determine whether any persons have violated, are violating or are about to violate the CEA or the CFTC’s regulations or orders. CFTC Regulation 11.2.CFTC or its delegated staff may issue subpoenas in the course of a particular investigation.CEA Section 8(a) authorizes the CFTC to conduct such investigations as it deems necessary to ascertain the facts regarding persons subject to the provisions to the CEA. You need not be a CFTC registrant to be engaged in activity subject to the CEA.CEA Section 8(d) authorizes the CFTC to investigate the marketing conditions of commodities.CEA Section 6(b) authorizes the CFTC to compel the attendance and testimony of witnesses and the production of documents.CEA Section 6(b) authorizes the CFTC to apply to a U.S. district court to compel compliance with a CFTC subpoena.In United States v. Morton Salt Co., the Supreme Court stated that a federal agency may investigate “merely on suspicion that the law is being violated or even just because it wants assurance that it is not . . . It too, may take steps to inform itself as to whether there is a probable violation of law.” In Oklahoma Press Pub. Co. v. Walking, the Supreme Court stated that an agency can investigate and determine whether its statute is applicable to particular conduct. See, e.g., SEC v. Brigadoon Scotch Distributing Co. (2d. Cir. 1993).In CFTC v. First National Bullion Corp., a district court enforced a CFTC subpoena stating that enforcement was appropriate where the investigation is for a proper statutory purpose, the information is relevant to the investigation, the required administrative steps have been followed, and the information is not within the CFTC’s possession. Non-compliance with the court’s subpoena enforcement order may constitute contempt of court. Coordinated CFTC/SEC EnforcementBitcoin-Funded Securities-Swap Dealer/Retail Commodity Dealer FCM. On September 27, 2018, in separate civil enforcement proceedings, each of the SEC and CFTC filed federal court complaints against 1Pool Ltd. a/k/a 1Broker and Patrick Brunner based on alleged dealing in securities-based swaps and swaps, which they called “contracts for differences,” funded by customers with bitcoins. 1Pool Ltd. is registered in the Marshall Islands. U.S. investors opened accounts by providing only an email address and user name, and could only fund their accounts with bitcoins. One of the U.S. investors was an undercover FBI agent, he and other U.S. investors were not “eligible contract participants” as defined in section 1a(18) of the CEA and as required for U.S. investors who trade in OTC security-based swaps and swaps. Security-based swaps are securities and therefore the SEC alleged that 1Pool was an unregistered dealer trading with non-ECPs. The CFTC complaint charged the defendants with engaging in unlawful retail commodity transactions (the undercover FBI agent was not an ECP), failing to register as an FCM, and AML supervisory violations.8

THE RANGE OF INVESTIGATIONS - JURISDICTION, PARALLEL, CROSS-BORDER, INDUSTRY SWEEPS (CONT’D) Cross-Border InvestigationsInternational Cooperation in EnforcementBeginning to appear. For example, July 2, 2018 announcement by leaders of tax enforcement authorities from Australia, Canada, the Netherlands, the United Kingdom, and the United States of establishment of joint operational alliance (“J5”) focusing, in part, on “cybercrime through the use of cryptocurrencies.”U.S. Prosecutors’ Access to Foreign EvidenceTypically reliant on cooperation of foreign law enforcement per individually negotiated, bi-lateral Mutual Legal Assistance Treaties (MLATs). Even where treaty exists, slow and cumbersome process.2018 CLOUD Act: Increases U.S. law enforcement’s ability to obtain through domestic processes (subpoenas/warrants) records kept overseas by U.S. providers of electronic communication services and remote computing services. Parallel DOJ/Agency InvestigationsMany SEC/CFTC investigations involve overt (or covert) participation of DOJ. Referred to as “parallel” investigations, but typically indistinguishable from joint investigations.May 2018: Reported that DOJ opened a parallel investigation with the CFTC into manipulation of the market for Bitcoin and other digital currencies. Even where DOJ participation is not apparent, prosecutors have frequently been contacted by the regulatory agency and are monitoring the progress of a regulatory investigation. DOJ has reasons why it generally will not use a regulatory agency as its cat’s paw to surreptitiously conduct a criminal investigation, but DOJ can obtain access to all of the investigative information that the regulatory agency collects in the agency’s regulatory investigation. Conversely, a regulatory agency does not have unfettered access to all of DOJ’s evidence. For example, DOJ cannot share information obtained by grand jury subpoena or wiretaps.9

TYPES OF REPRESENTATIONS - CTAs, CPOs, FCMs CTAs, CPOs and FCMs are subject to the CFTC and the NFA’s investigation and enforcement authority.All persons who trade on regulated futures exchanges are subject to the market surveillance and enforcement authority.FCMs must notify the NFA when they first trade virtual currency futures.CPOs and CTAs must notify the NFA when they first trade virtual currency derivatives (futures or swaps) or any other virtual currency transaction, i.e., spots or forwards.Acting as an FCM or CTA for an investment fund that (a) trades virtual currency spot or forward transactions and (b) has retail investors, will be subject to the CFTC’s scrutiny. Appropriate due diligence and legal reviews are vital.Persons who advise retail customers in respect of virtual currency transactions that are not derivatives may find that they are acting as unregistered CTAs advising on retail commodity transactions.FCMs who carry accounts for retail virtual currency investors or for investment funds that trade virtual currencies spot or forward contracts, to the extent their customers undergo CFTC scrutiny, will also be the subject of the CFTC’s investigation.In 2017, the CFTC revised its policies concerning the cooperation of entities and individuals in a CFTC investigation and enforcement proceeding. Cooperation factors are materiality, timeliness, nature, quality, self-remediation and the identification of individual wrongdoers. Cooperation credit may result in less severe enforcement remedies.Important Takeaways CFTC registrants may consider reporting their own or others’ violations to the CFTC and cooperating in a CFTC inquiry. Conduct appropriate due diligence on any cryptocurrency platform, issuer or dealer with whom you are engaging in business. Consider potential reputational risk as well as legal and regulatory risks when engaging in any cryptocurrency or ICO transactions.10

TYPES OF REPRESENTATIONS – EXCHANGES In the Matter of BFXNA Inc, d/b/a Bitfinex, CFTC Dkt. No. 16-19 (Jun. 2, 2016) Illegal, off-exchange financed retail commodity transactions/failure to register as an FCM$75,000 CMPAdvisory with respect to Virtual Currency Derivative Product Listings, CFTC Staff Advisory No. 18-14 (DMO, DCR, May 21, 2018) “Clarif[ying] the Commission Staff’s priorities and expectations in its review of new virtual currency derivatives.” Enhanced market surveillance Coordination with CFTC staff Large trader reporting Outreach to stakeholders DCO risk managementStatement on Potentially Unlawful Online Platforms for Trading Digital Assets (SEC DOE, DTM Mar. 7, 2018) “The SEC staff has concerns that many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not.  Many platforms refer to themselves as ‘exchanges,’ which can give the misimpression to investors that they are regulated or meet the regulatory standards of a national securities exchange.” Listing Standards Trading ProtocolsData IntegrityImportant Takeaways Structure of trading could trigger registration requirements. While standards the same, scrutiny likely to be greater. Exchanges may provide easier enforcement targets than promoters. How will regulators address decentralized/hybrid trading platforms?11

TYPES OF REPRESENTATIONS - CRYPTOCURRENCY PROMOTORS AND PLATFORMS In the Matter of Tomahawk Exploration LLP et al., Ad. Pro. File No. 3-18641 (SEC Aug. 14, 2018)CFTC Violations of Section 5 of the Securities Act, Section 10(b) of the Exchange ActDistribution in exchange for marketing services; tokens convertible into equity; fraud02/16/2018FOR IMMEDIATE RELEASE2018-20Washington D.C.  —  The Securities and Exchange Commission today suspended trading in three companies amid questions surrounding similar statements they made about the acquisition of cryptocurrency and blockchain technology-related assets.In the Mattre of TokenLot, LLC, et al., Ad. Pro File No. 3-18739 (SEC Sept. 11, 2018)CFTC Violations of Section 15(a) of the Exchange Act, Section 5(a) of the Securities Act Acting as a broker and as a dealer on ICOs and secondary market transactions Sanctions included destruction of inventory of tokens 09/7/2018Wyre Acquires Bitcoin Smart Contract Derivatives Platform HedgyCrypto payments startup Wyre has acquired 100 percent of Hedgy, a venture-backed bitcoin smart contract development firm, for an undisclosed sum. . . . [A]cquiring a smart contract platform will aid Wyre provide a wider financial ecosystem to crypto startups, according to Giannaros, with access to financial instruments such as forward contracts, swaps and more.Important TakeawaysSection 5 violations are low-hanging fruit for SEC because of strict liability; Trading suspension even easier to implement.“Creative” sanctions possible in this new frontier.Smart contracts may become hazardous if embedded algorhythms are not carefully vetted.12

CRYPTOCURRENCY CONDUCT ISSUES - FRAUD Federal Task ForceExecutive Order Regarding the Establishment of the Task Force on Market Integrity and Consumer Fraud (President Donald J. Trump, July 11, 2018).Includes federal financial regulators, DOJ, CFTC, SEC, FTC and CFPB.Coverage includes “digital currency fraud.”To develop guidance for cryptocurrency fraud investigations.Protection for consumers in the emerging cryptocurrency markets.StatesNorth American Securities Administrators Association’s “Operation Cryptosweep” (April 2018).Coordinated series of investigations by states and Canadian provinces into ICOs and cryptocurrency-related investment products.Modeled after a NASAA-led state and provincial fight against internet stock fraud in the late 1990s. NASAA is also coordinating with the CFTC and SEC. More than 200 inquiries and 46 enforcement actions relating to ICOs and cryptocurrencies since May 2018. Department of JusticeUnited States v. Sharma, et al., criminal indictment, May 14, 2018 (S.D.N.Y.).Indictment of founders of Centra Tech.Allegedly made false claims about their product and about relationships with credible financial institutions, including a purported debit card (the “Centra Card”), that supposedly allowed users to spend various types of cryptocurrencies to make purchases at any business where Visa or Mastercard cards were accepted, about their executives’ credentials, and about having money transmitter licenses in 38 states. Offered cryptocurrency-related financial products through an ICO.Alleged scheme to induce victims to invest in digital currency tokens issued by Centra Tech for the purchase of unregistered securities.FBI seized 91,000 Ether units worth more than $60 million, representing digital funds raised from the victims. 13

CRYPTOCURRENCY CONDUCT ISSUES - PONZI SCHEMES “Scanners are making big money off people who want in on the latest digital gold rush but don’t understand how the technology works.” The Rise of Cryptocurrency Ponzi Schemes, The Atlantic (May 2017). “When market participants engage in fraud under the guise of offering digital instruments — whether characterized as virtual currencies, coins, tokens, or the like — the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.” Joint statement from CFTC and SEC Enforcement Directors Regarding Virtual Currency Enforcement Actions (Jan. 19, 2018), http://www.cftc.gov/PressRoom/SpeechesTestimony/mcdonaldstatement011918. Also on January 19, 2018, CFTC Chairman Giancarlo delivered a speech on virtual currency in which he stated that “[t]he CFTC believes that the responsible regulatory response to virtual currencies involves asserting CFTC legal authority over virtual currency derivatives in support of anti-fraud and manipulation enforcement, including in underlying spot markets.” J. Christopher Giancarlo, Remarks of Chairman J. Christopher Giancarlo to the ABA Derivatives and Futures Section Conference, Naples, Florida (Jan. 19, 2018), http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo34. The Chairmen of the SEC and CFTC wrote a joint op-ed for the Wall Street Journal addressing the oversight of virtual currency. They stated their agencies along with other federal and state regulators and criminal authorities will continue to work together to deter and prosecute fraud and abuse. Wall Street Journal (January 25, 2018). CFTC In September 2017, the CFTC charged an individual and his company with fraud, misappropriation and issuing false account statements in connection with solicited investments in Bitcoin. The defendants were accused of operating a Ponzi scheme, whereby investors were encouraged to place their funds in a pool that would be managed by using ‘a high-frequency, algorithmic trading strategy.’ CFTC v. Gelfman Blueprint, Inc. et al., No. 1:17-cv-07181 (S.D.N.Y. Sept. 21, 2017). On January 18, 2018, the CFTC filed two lawsuits in federal court alleging fraud in connection with the trading of virtual currency. One involved allegations that the perpetrators were promoting a pooled investment vehicle in which the investors would contribute Bitcoin, which would be converted into fiat currency and then used to trade various commodity interests. CFTC v. Dean, et al., No. 2:18-cv-00345 (E.D.N.Y. Jan. 18, 2018). The other case involved an allegation of trading advice relating to trading of virtual currencies themselves. CFTC v. McDonnell, et al., No. 1:18-cv-00361-JBW-RLM, slip op. (E.D.N.Y. Mar. 6, 2018) (mem.). Both cases involved allegations that the defendants misappropriated the funds.14

CRYPTOCURRENCY CONDUCT ISSUES - PONZI SCHEMES (CONT’D) On January 24, 2018, the CFTC announced that it had filed an enforcement action alleging misappropriation of over $6 million in funds from customers. In this instance, the allegations focused on misrepresentations about how the form of virtual currency being promoted, My Big Coin, could be used with merchants and others to process transactions, and that it was backed by gold. CFTC v. My Big Coin Pay, Inc., et al., No. 1:18-cv-10077-RWZ (Dist. Mass. Filed January 16, 2018). On March 6, 2018, a district court held that CEA section 6(c)(1), as implemented by CFTC Rule 180.1, grants the CFTC jurisdiction to bring cases for fraud in cash markets in general and virtual currency in particular. The alleged fraud involved purported consulting services and trading advice relating to Bitcoin and another virtual currency, Litecoin. On August 23, 2018, following a non-jury trial, the case was decided in favor of the CFTC. See CFTC v. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets, No. 1:18-cv-00361 (E.D.N.Y. Aug. 23, 2018), https://www.cftc.gov/sites/default/files/2018-08/enfdropmarketsorder082318.pdf. SECThe SEC’s enforcement jurisdiction is more limited than the CFTC’s because the SEC can only bring actions involving instruments falling within the definition of “security.” In 2017, the SEC’s Division of Enforcement formed a Cyber Unit, which it stated would focus on market manipulation, hacking to obtain MNPI, violations involving distributed ledger technology and ICOs, among other issues. In July 2017, the SEC found that the tokens offered and sold by “The DAO” were securities, and thus subject to the requirements of the federal securities laws.In September 2017, the SEC brought charges against an individual and his two companies for fraud in two ICOs purported to be backed by investments in real estate and diamonds. In the case of the second company, the allegations were that they claimed to have purchased diamonds and engaged in other business operations when they had actually done nothing in that regard. SEC v. REcoin Group Foundation, LLC, et al., No. 17-cv-05725 (E.D.N.Y Sept. 29, 2017). In December 2017, the SEC charged a Canadian individual and his company with fraudulently marketing tokens to U.S. investors (and thus also violating the registration provisions of the U.S. securities law), and obtained an emergency asset freeze. SEC v. PlexCorps, et al, No.1:17-cv-07007-DLI-RML (E.D.N.Y. Dec. 1 2017). 15

CRYPTOCURRENCY CONDUCT ISSUES - PONZI SCHEMES (CONT’D) In May 2018, the SEC filed a complaint and obtained an emergency asset freeze, and then a consented-to preliminary injunction and appointment of a receiver, in connection with an alleged ongoing fraudulent ICO that had raised $21 million by a self-described “blockchain evangelist” who had misrepresented his business relationship with the Fed and many well-known companies. SEC v. Titanium Blockchain Infrastructure Services, Inc., et al., No. 18-cv-4315-DSF (JPRx) (C.D. Cal. filed May 22, 2018); see also SEC v. Arisebank, et al., No. 18-cv-00186 (N.D. Tex. Jan. 25, 2018) (allegedly fraudulent ICO in connection with a claim of creating the world’s first ‘decentralized bank’); SEC v. Sharma, et al., No. 18-cv-02909-DLC (S.D.N.Y. Apr. 2, 2018) (allegedly fraudulent $32 million ICO).In February 2018, the SEC brought an action against a former platform and its operator for operating an unregistered securities exchange and also for defrauding users of the exchange. The exchange offered what the SEC alleged were securities in “virtual currency-related enterprises in exchange for [B]itcoins.” The operator of the exchange was also charged with fraud in connection with an illegally unregistered token offering. SEC v. Montroll, et al., No. 1:18-cv-01582 (S.D.N.Y. Feb. 21, 2018).Important TakeawaysThe CFTC and SEC have focused their enforcement efforts on Ponzi schemes and other frauds involving virtual currencies and ICOs. Offering and selling non-existent virtual currencies funds may be subject to the CFTC’s and/or SEC’s enforcement jurisdiction. FCMs or broker-dealers who carry accounts for what may be fraudulent or Ponzi-type funds involving virtual currencies are in the crosshairs of the agencies. 16

CRYPTOCURRENCY CONDUCT ISSUES - RETAIL CUSTOMER ABUSE Section 2(c)(2)(D) of the CEA broadly applies to any agreement, contract, or transaction in any commodity that is entered into with, or offered to, a non-eligible contract participant (“ECP”), or non-eligible commercial entity on a leveraged, margined, or financed basis where “actual delivery” of the commodity is not made within 28 days. This provision characterizes such agreements, contracts, and transactions as unlawful off-exchange futures contracts subject to section 4(a) of the CEA. Virtual currencies are commodities. Retail investors are individuals who are not “eligible contract participants.” Retail commodity transactions are treated under the CEA as futures contracts and must be traded on regulated DCMs. OTC retail commodity transactions that violate section 2(c)(2)(D) are unlawful.In 2016, in an administrative enforcement proceeding, the CFTC entered into a settlement with Bitfinex, which operated an online platform for retail customers exchanging and trading various virtual currencies, including Bitcoins, on a margined, leveraged or financed basis, without actually delivering the Bitcoins to the retail customers but instead holding the Bitcoins in wallets that it owned and controlled, in violation of the CEA’s “retail commodity transactions” provision that is intended to protect individual retail customers from abuse involving unregulated speculative commodities investments. In the Matter of BFXNA Inc. d/b/a Bitfinex, CFTC No. 16-19 (June 2, 2016). The transactions were illegal, off-exchange commodity futures contracts because they were transacted with retail investors and did not result in actual delivery. In 2017, the CFTC published a proposed interpretation on the meaning of the term “actual delivery” in the context of retail transactions in virtual currencies, in order to determine whether off-exchange transactions involving virtual currencies fall within the CEA’s retail commodity transactions prohibition. Retail Commodity Transactions Involving Virtual Currency, 82 Fed. Reg. 60335 (Dec. 20, 2017). The CFTC advised that it will look to whether, no later than within 28 days, the retail customer is able to take possession and control of the entire quantity of the virtual currency purchased, regardless of whether the purchase was leveraged or financed, and use it freely in commerce without the seller or platform retaining any security interest in the virtual currency. Book-out or cash settlement, or where the virtual currency is retained in an omnibus wallet where the platform operator retains the private keys, will not constitute actual delivery. The CFTC recognized that a virtual currency trading platform may have relationships with depositories for its customers, but the platform (and any financing provider) may not retain an interest in the virtual currency deposited in the depository. On September 27, 2018, the CFTC filed a civil enforcement action in federal court against an alleged unregistered FCM acting in violation of section 4d(a)(1) of the CEA who solicited or accepted orders from U.S. non-ECPs for speculative retail commodity transactions, acted as a counterparty to the transactions, and required bitcoin from the investors to fund the transactions. The transactions were “contracts for differences” based on gold, oil and other commodity prices. The CFDs settled in bitcoin on the defendants’ platform without any requirement for delivery/physical settlement. The CFTC alleged that the CFDs violated section 2(c)(2)(D) of the CEA and were unlawful off-exchange futures contracts. CFTC v. 1Pool Ltd. and Patrick Brunner, Case No. 1:18-cv-2243 (D.C. Sept. 27, 2018). On the same day, the SEC commenced an enforcement action against the defendants based on those CFDs that were security-based swaps. Important TakeawaysOffering and selling virtual currency investments to retail investors is a path to a close encounter with the CFTC.What constitutes “actual delivery” of virtual currencies is an open issue.17

CRYPTOCURRENCY CONDUCT ISSUES - MANIPULATION WSJ, Aug. 5, 2018Traders Are Talking Up Cryptocurrencies, Then Dumping Them, Costing Others Millions“Dozens of trading groups are manipulating the price of cryptocurrencies on some of the largest online exchanges, generating at least $825 million in trading activity over the past six months—and hundreds of millions in losses for those caught on the wrong side, according to a Wall Street Journal analysis.“In a review of trading data and online communications among traders between January and the end of July, the Journal identified 175 ‘pump and dump’ schemes involving 121 different digital coins, which show a sudden rise in price and an equally sudden fall minutes later.”Bloomberg, May 24, 2018U.S. Launches Criminal Probe into Bitcoin Price Manipulation“The Justice Department has opened a criminal probe into whether traders are manipulating the price of Bitcoin and other digital currencies, dramatically ratcheting up U.S. scrutiny of red-hot markets that critics say are rife with misconduct, according to four people familiar with the matter. “The investigation is focused on illegal practices that can influence prices -- such as spoofing, or flooding the market with fake orders to trick other traders into buying or selling, said the people, who asked not to be identified because the review is private. Federal prosecutors are working with the Commodity Futures Trading Commission, a financial regulator that oversees derivatives tied to Bitcoin, the people said.” Repeated SEC rejection of ETF applications for failure to meet “the requirement that [the product] be designed to prevent fraudulent and manipulative acts and practices.” Important TakeawaysNoise, but no action – yet.CFTC likely anxious to plant its flag in this space.Remember for attempted manipulation, CFTC needs only evidence of intent, an act in furtherance.18

CRYPTOCURRENCY CONDUCT ISSUES - INSIDER TRADING March 5, 2018Coinbase Is Getting Sued for Insider TradingThe lawsuit alleges that some were tipped off ahead of the release of Bitcoin Cash on the platform.Possible liability under CEAPossible liability under SEASept. 5, 2018Someone Took Out a $74 Million Short on Bitcoin Right Before the DropAn unidentified trader shorted 10,000 BTC prior to the Goldman Sachs-driven sell-off.“The latest evidence of potential manipulation within the Bitcoin market comes with the latest downturn, as an unidentified investor took out a massive short position on BTC just days prior to the major sell-off fueled by leaked insider information pertaining to Goldman Sach’s decision to halt its efforts to build a Bitcoin (BTC) trading desk.” Important Takeaways Both CFTC and SEC will pursue insider trading theories. DOJ may be willing to characterize insider trading as fraud in some circumstances. SEC insider trading could apply to coins not labelled as securities, but later viewed as securities by the SEC.19

Please do not hesitate to contact any of us:Geoffrey Aronow, Partner, (202) 736-8023, garonow@sidley.comMichael Levy, Partner, (212) 839-7341, mlevy@sidley.comMichael Sackheim, Senior Counsel, (212) 839-5503, msackheim@sidley.comTimothy J. Treanor, Partner, (212) 839-8564, ttreanor@sidley.comThis power point presentation is for informational purposes only and does not constitute legal advice.  This information is not intended to create, and the receipt of it does not constitute,a lawyer-client relationship. Readers and attendees should not act upon this information without seeking advice from professional advisers. The content of this article does not reflect the views of Sidley Austin LLP. 20