August 14, 2022

Volume XII, Number 226

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August 11, 2022

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May 2022 Crypto Enforcement Actions and Regulatory Guidance Roundup

In May, we saw a slower month for crypto enforcement actions by state and federal regulators. See our March 2022 Crypto Enforcement Actions Roundup blog here where we discuss the regulatory guidance and jurisdiction of federal and state agencies to enforce these matters.

Federal and State Updates

Securities and Enforcement Commission (SEC)

On May 3, the SEC announced “the allocation of 20 additional positions to the unit responsible for protecting investors in crypto markets and from cyber-related threats.” Accordingly, the Crypto Assets and Cyber Unit in the Division of Enforcement will be expanded to “50 dedicated positions.”The Crypto Assets and Cyber Unit has brought enforcement actions regarding securities law violations and for failure to maintain “adequate cybersecurity controls”—including negligent practices in disclosing cyber-related risks and incidents. The expansion demonstrates the SEC’s intent to ramp up enforcement efforts, which we will watch closely.

Department of Treasury

On May 10, Treasury Secretary Janet Yellen presented the Financial Stability Oversight Council (FSOC) Annual Report before the Senate Banking Committee about the need for sensible stablecoin legislation (we have previously discussed the President’s Working Group (PWG) report on stablecoins here and here).  Secretary Yellen cites the findings in the PWG report as reason to conclude that “the current statutory and regulatory frameworks don’t provide consistent and comprehensive standards for the risks of stablecoins as a new type of payment products and urges Congress to enact legislation to ensure that stablecoins and such arrangements have a federal prudential framework.”

Commodity Futures Trading Commission (CFTC)

On May 19, the CFTC charged several individuals for fraudulently soliciting at least $44 million for participation interests in a so-called “income fund” investing in digital assets and other instruments. The enforcement action also charges the defendants with operating an illegal commodity pool and failing to register as a Commodity Pool Operator. The complaint alleges that since at least January 2021, the defendants solicited more than $44 million from at least 170 participants to purchase, hold and trade digital assets, commodities, derivatives, swaps, and commodity futures contracts. The complaint also alleges that instead of investing the pooled participant funds as advertised, the defendants misappropriated participant funds by distributing them to other participants, transferring some participant funds to other accounts under their control and for their benefit, and transferring funds to a foreign cryptocurrency exchange. None of these funds were returned to the pool.

On May 19, Rostin Behnam, Chairman of the CFTC publicly remarked that the CFTC will add resources and increase its efforts to address cryptocurrency-related fraud and manipulation cases. He stated, “[h]eadlines about the loss of tens of millions of dollars in digital assets due to protocol exploits, phishing attacks, preying on vulnerable people and other fraudulent and manipulative schemes have become far too common.” This statement is a clear signal of what actions the CFTC will likely pursue.

Financial Crimes Enforcement Network (FinCEN)

On May 19, Alessio Evangelista, the Associate Director of the Enforcement and Compliance Division of FinCEN, presented at the Chainalaysis Links Conference on the topic of “Intersection of Cryptocurrencies and National Security.”  Evangelista stated that crypto firms “have the same obligations as all other financial institutions to ensure that their new offerings can leverage innovations while still protecting consumers, reducing cybercrime, combating illicit financial activity, and ensuring their platforms are not used to harm our national security.” He also stressed that the agency believes that innovation goes hand in hand with regulation, rather than being at odds with each other.

Evangelista also stated that virtual asset service providers (VASPs) ignore red flags and continue to do business with problematic companies far too often.  He called on these VASPs to be proactive with regulatory compliance and to avoid having “paper programs” or compliance regimes that exist on paper but are not implemented, either by mistake or design. Here, FinCEN will continue to prioritize cases where it identifies “significant non-compliance and threats” to the financial system and where it finds “willful disregard for regulatory requirements.”

Office of the Comptroller of the Currency

On May 24, the acting Comptroller of the Currency, Michael Hsu remarked at the DC Blockchain Summit 2022 on the “deep” vulnerabilities of cryptocurrency in light of the recent market volatility and other events in the crypto economy.  Hsu emphasized the vulnerabilities arising from new blockchains spinning up operations.  Particularly, the crypto ecosystem has become increasingly fragmented, which presents interoperability issues. Cross-chain bridges, although providing a solution to these issues, are highly prone to being hacked.

Hsu also emphasized that the interconnectedness of the crypto ecosystem presents real contagion risks, as evidenced by the recent collapse of a popular algorithmic stablecoin, which caused other stablecoins to drop in value. Moreover, Hsu cited the lack of clear standards for the ownership and custody of digital assets as placing consumers at risk.  Hsu believes these standards are underdeveloped given the size, scope, and ambitions of the industry. For example, the largest U.S. centralized exchange recently disclosed that its users would be at risk of becoming unsecured creditors if the exchange were to file for bankruptcy.

Hsu also observed that despite the volatility and loss of market capitalization after the recent stablecoin collapse, there has been no stress on traditional banking and finance due to crypto exposure, a result which he attributes, at least in part, to federal bank compliance and intentional emphasis on safety, soundness, and consumer protection.  Hsu found this to be a result of the OCC’s “careful and cautious” approach to banks seeking to join the crypto economy, referenced in Interpretive Letter 1179 issued last year (we previously discussed this letter in a blog post here).

California State

Under a recent Executive Order signed by Governor Gavin Newsom on May 4th, California is urging all state agencies to work with the federal government in creating regulations for digital assets. The executive order explains the importance of this action in recognition of the fact that “California is the global innovation hub for emerging technologies because of the State’s unparalleled concentration of research and development, human and venture capital, and creativity and entrepreneurialism.”

Under the executive order, the state has seven priorities: (1) to create a transparent and consistent business environment for companies operating in blockchain; (2) to work concurrently and cooperatively with President Biden’s strategy and efforts to identify responsible regulation; (3) to collect feedback from a broad range of stakeholders for potential blockchain applications and ventures; (4) to engage in a public process and exercise statutory authority to develop a comprehensive regulatory approach to crypto; (5) to engage in and encourage regulatory clarity via progress on the processes outlined in the federal executive order; (6) to explore opportunities to deploy blockchain technologies to address public-serving and emerging needs; and (7), to identify opportunities to create a research and workforce environment to power innovation in blockchain technology.

Enforcement Actions

The Justice Department

On May 13, the Justice Department initiated its first criminal prosecution involving the alleged use of cryptocurrency to evade economic sanctions. Magistrate Judge Zia M. Faruqui explained in a 9-page decision that “cryptocurrency’s reputation for providing anonymity to users” is a “myth,” asserting that virtual currencies such as bitcoin, Ethereum or Tether are subject to the U.S. sanctions laws even though they are outside of the traditional financial system. Judge Faruqui explained that “OFAC’s recent guidance confirmed that ‘sanctions compliance obligations apply equally to transactions involving virtual currencies and those involving traditional fiat currencies.” The complaint continued, “the Department of Justice can and will criminally prosecute individuals and entities for failure to comply with OFAC’s regulations, including as to virtual currency.”

Conclusion

The crypto-regulatory and enforcement landscape remains a convoluted patchwork.  There are many legal considerations involving NFTs, crypto, and other Web3 technologies.  What is not murky, however, is the clear stance by U.S. regulators that, notwithstanding the novelty of the technology and asset class, basic principles still apply:  registered or not, developers, protocols, projects and platforms can’t defraud retail investors; they can’t aid and abet money laundering; and they can’t violate sanctions. 

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XII, Number 158
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About this Author

Michael J. Gilbert Attorney Prosecutor Government Sheppard Mullin New York
Partner

Michael Gilbert is a partner in the Government Contracts, Investigations and International Trade practice group in the firm's New York office.

Areas of Practice

Michael, a former federal prosecutor, served as an Assistant U.S. Attorney (AUSA) in the Southern District of New York prior to entering private practice.  While serving as an AUSA, he investigated and prosecuted matters involving a wide variety of federal criminal laws, including mail and wire fraud, bribery, healthcare fraud and violations...

212-896-0611
Associate

Gabriel is an Associate on the Telecom team and the Co-Lead Associate on the Blockchain and Digital Assets team in the firm’s Washington, D.C. office. He is a Blockchain Law Professional as Certified by the Blockchain Council.

At Sheppard Mullin, Gabriel assists the Telecom team in all aspects of communications law and regulation including, satellites, spectrum, 5G implementation, media companies, and new technologies. He assists the Blockchain and Digital Assets team in legal issues relating to the use of blockchain technology, social media, internet, video games, online gambling,...

202-747-2194
Zachary Golda Business Lawyer Sheppard Mullin Law Firm Orange County
Associate

Zachary Golda is an associate in the Business Trial Practice Group in the Orange County office.

Areas of Practice

Zachary’s practice focuses on general business litigation, including breach of contract, business torts, insurance, sports, and other high-stakes business litigation matters.

Zachary helps clients reach successful outcomes, including favorable settlements and dismissal of cases prior to discovery. For example, while defending an insurance carrier and its parent company from an institutional bad faith claim, Zachary helped draft  a...

714.424.8216
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