March 1, 2021

Volume XI, Number 60

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March 01, 2021

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Busy day for CFTC and SEC Cryptocurrency Regulators: Enforcement Actions, a Public Letter, and Joint Statement

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 viewof 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.

Takeaways  

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.

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© 2020 Proskauer Rose LLP. National Law Review, Volume VIII, Number 24
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About this Author

Michael F Mavrides, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Michael F. Mavrides is a Partner in the Hedge Funds Group. Mike focuses his practice on representing domestic and offshore hedge funds, funds of funds and other private investment funds, including private equity and real estate investment funds. He regularly advises funds and their managers on a wide variety of issues, including formation and structuring, seed capital, anchor capital and other strategic arrangements, placement agency, solicitation and other marketing arrangements, succession planning, separately managed accounts, and all types of portfolio management, trading and...

212-969-3670
Robert Plaze, Investment Manager Attorney, Regulatory and Compliance
Partner

Robert E. Plaze is a partner and a member of the Investment Management team. He advises investment advisers and investment companies on an array of matters, with a particular focus on regulatory and compliance matters arising under the federal securities laws.

Bob previously served as Deputy Director of the Division of Investment Management of the U.S. Securities and Exchange Commission. During his nearly 30 years of service with the Commission, he was responsible for policy development and management of many of the key regulatory initiatives during that period affecting investment...

202-416-6692
Trevor Dodge Capital Markets Attorney
Associate

Trevor Dodge is an associate in the Capital Markets Group at Proskauer. He represents underwriters and issuers in public and private capital markets transactions. He also advises blockchain companies on security token offerings and other matters implicating the rules and regulations promulgated by the SEC, CFTC, FinCEN and various state agencies.

Trevor holds a J.D. from NYU School of Law, where he was a staff editor for the Journal of Intellectual Property & Entertainment Law. While at NYU, Trevor interned for the World Bank Group in New Delhi and assisted with the New...

212-969-3576
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