March 2022 Crypto Enforcement Actions Roundup
In the wake of President Biden’s March 9, 2022, executive order outlining his Administration’s desire to establish a comprehensive federal approach to crypto policy and regulation, federal agencies are continuing to focus on enforcement of crypto under existing regulations. Although NFTs and cryptocurrencies are novel technologies, they still fall squarely within the jurisdiction of various federal agencies’ current jurisdictions, as illustrated by three recent enforcement actions by the CFTC, the SEC, and the DOJ.
As illustrated below, the crypto and NFT space is ripe for regulatory clarity. In the meantime, several federal agencies have provided non-dispositive guidance.
Securities and Exchange Commission (“SEC”). The SEC has been one of the most active agencies in the crypto area. The SEC regulates securities and securities exchanges. While the only true guidance the crypto industry has received is the Framework for “Investment Contract” Analysis of Digital Assets, there are several no-action letters, settlements, reports, and complaints that may provide additional guidance. Please contact one of our attorneys to assist in interpreting these actions to your specific situation.
Commodities Futures And Trading Commission (“CFTC”). The CFTC has issued several customer protection Fraud Advisories and Articles that provide the warning signs of fraud, including one to inform the public of possible risks associated with investing or speculating in virtual currencies or recently launched Bitcoin futures and options. The CFTC has also issued various primers. The CFTC published the Primer on Virtual Currencies which is “an educational tool regarding emerging fintech innovations.” The CFTC also published the Primer on Smart Contracts that cautioned about the risks of smart contracts.
Financial Crimes Enforcement Network (“FinCEN”). FinCEN has released guidance on the application of FinCEN’s Regulations to virtual currencies.
Department of Treasury. The Department of the Treasury published a study on the facilitation of money laundering and terrorist financing through the art trade and options to address these issues.
Internal Revenue Service (“IRS”). The IRS released guidance addressing how existing general tax principles apply to transactions using virtual currency. The IRS also issued a collection of guidance on taxation of virtual currencies. It can be found here. The IRS also published Frequently Asked Questions on Virtual Currency Transactions for individuals who hold cryptocurrency as a capital asset and are not engaged in the trade or business of selling cryptocurrency.
State Agencies. Many states are considering pending legislation dealing with crypto assets resulting in inconsistent definitions of crypto assets. Many state financial regulation agencies have also asserted jurisdiction over crypto currency. Most states have money transmitter laws that require companies to obtain a license in that state if they engage in money transmission services. Some states, such as New York, impose a separate requirement to obtain a “BitLicense.” Subject to certain exceptions, anyone engaging in any of the following activities may be required to obtain a BitLicense in New York: (i) virtual currency transmission; (ii) storing, holding, or maintaining custody or control of virtual currency on behalf of others; (iii) buying and selling virtual currency as a customer business; (iv) performing exchange services as a customer business; or (v) controlling, administering, or issuing a virtual currency.
Recent Enforcement Actions
On March 8, 2022, the CFTC charged four individuals with fraud for operating a bitcoin Ponzi scheme on the asserted basis that bitcoin is a commodity subject to the CFTC’s enforcement jurisdiction. The complaint alleges that the defendants fraudulently solicited more than $21 million of bitcoin by promising potential investors that professionals traders would manage their bitcoin portfolios and guaranteeing trading profits to be paid daily. Instead, the defendants misappropriated customers’ bitcoin or used it to pay alleged profits to customers that had signed up earlier. The CFTC filed this action in the U.S. District Court for the Eastern District of New York seeking restitution, disgorgement, civil monetary penalties, permanent trading and registration bans, and a permanent injunction against further violations of the Commodity Exchange Act (“CEA”) and CFTC regulations, as charged. In a parallel action, the individuals were also charged with wire fraud, money laundering, and a separate individual was charged with obstruction of justice in the U.S. District Court for the Eastern District of New York.
Also on March 8, 2022, the Securities and Exchange Commission charged two defendants with defrauding thousands of retail investors out of more than $124 million through unregistered securities offerings involving Ormeus Coin, a digital token created by the defendants. The SEC alleged that the defendants sold the token through subscription packages solicited to investors on crypto trading platforms and falsely claimed the token was backed by a $250 million crypto mining operation producing $5.4 million to $8 million per month in mining revenues. The defendants also allegedly falsified a website to display a fake wallet containing more than $190 million in digital assets, even though the token wallets were worth less than $500,000. The SEC filed this action in the U.S. District Court for the Southern District of New York, charging the defendants with violating federal securities laws and seeking injunctive relief, disgorgement plus interest, and civil penalties. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York unsealed criminal charges against one of the defendants.
On March 24, 2022, the Department of Justice (“DOJ”) charged two individuals with conspiracy to commit wire fraud and conspiracy to commit money laundering in connection with a million-dollar NFT fraud. According to the complaint, the defendants promised that purchasers of their “Frosties” NFTs would be eligible for holder rewards, including giveaways, early access to a metaverse game, and exclusive mint passes to upcoming Frosties seasons. However, rather than providing the benefits advertised to the NFT purchasers, the defendants transferred the cryptocurrency proceeds of the scheme to various cryptocurrency wallets under their control. DOJ called the scheme an NFT “rug pull,” and noted the scheme’s increasing popularity among criminal actors. As the term suggests, a rug pull refers to a scenario where the creator of an NFT and/or gaming project solicits investments based on the promise of building utility for the NFTs but then abruptly abandons the project and retains the project investors’ funds. Before their arrests, the defendants were preparing to launch a second set of NFTs which was anticipated to generate approximately $1.5 million in cryptocurrency proceeds. The defendants were charged with one count to commit wire fraud, in violation of 18 U.S.C. § 1349, and one count of conspiracy to commit money laundering, in violation of 18 U.S.C. § 1956(h).
Federal Crypto Regulatory Mindset
Blockchain and Web3 (which we previously discussed here) present federal agencies with a novel enforcement target. However, as these three cases demonstrate, these technologies are still subject to existing civil and criminal regulations, including good old-fashioned, plain vanilla fraud. This message is not new. In 2019, the SEC published the Framework for “Investment Contract” Analysis of Digital Assets (“Framework”). In the Framework, the SEC asserted that a test developed by the U.S. Supreme Court in 1946 to identify investment contracts that were securities also applies to digital asset securities. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (“Howey”). In the Howey case, the U.S. Supreme Court held that an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. The Howey test as applied to crypto and NFTs is fact-intensive and token-specific (reach out to one of our experienced attorneys to inquire about obtaining a Howey analysis for your specific token).
Federal regulators and law enforcement have signaled that they will increasingly focus on crypto, NFTs, and other Web3 technologies. Commenting on the March 8 SEC charges, Melissa Hodgman, Associate Director in the SEC’s Division of Enforcement said, “[w]e will continue to vigorously pursue persons who sell securities in schemes to defraud the investing public no matter what label the promoters apply to their products.” Recently, the Department of Justice announced the creation of a National Cryptocurrency Enforcement Team to tackle complex investigations and prosecutions of criminal misuses of cryptocurrency. Additionally, the SEC has announced its examination priorities for the fiscal year 2022, among them is crypto-assets. Specifically, the SEC is targeting robo-advisers, fractionalization, and other crypto-custody arrangement practices (which we previously discussed here). These are just a few examples that indicate more serious and more frequent crypto regulations and enforcement actions are forthcoming.
The world of crypto regulation is currently a complex, convoluted patchwork of existing regulations. Regardless, recent actions have proven that if your conduct using NFTs or other tokens falls under the jurisdiction of any one of the myriad agencies, you may be a target of enforcement actions. There are many legal considerations that are involved with NFTs, crypto, and other Web3 technologies and our attorneys have been assisting companies, individuals, and exchanges comply with existing regulation for many years.
 See our blog on the executive order here.