The Rise of the 'Crypto Czar,' the Fall of a 'Blockchain Evangelist'

Commissioner Behnam stated that "[w]e are witnessing a technological revolution" that might be better described as "a modern miracle."

The CFTC official's praise of virtual currency was not without qualification. While in one breath Commissioner Behnam suggested that virtual assets could become "the single greatest weapon against corruption" because they could help—with the assistance of cell phones—to  "put money directly into the hands of those who need it, without bribery, rake-offs, graft, and shakedowns," his next breath struck a more dystopian tone when he acknowledged that the same technology could be subverted as "a weapon against the work of the United Nations and others trying to alleviate poverty or violence" because "[v]irtual assets become a means of deeper control of wealth and a means of exploitation."

According to Commissioner Behnam, the CFTC is trying to address the challenges posed by virtual currencies through a mix of regulation and enforcement. On the regulation front, he noted that two exchanges in 2018 have self-certified several new contracts for futures products for virtual currencies and projected that others will follow suit. On the enforcement front, Commissioner Behnam noted that during the past several weeks the CFTC has filed a series of civil enforcement actions against perpetrators of fraud and market abuse involving virtual currency.  He noted that these actions—and others to follow—confirm that the CFTC, in coordination with the SEC and "other fellow financial enforcement agencies," is "aggressively prosecut[ing] those who engage in fraud and manipulation of US markets for virtual currency."

Key Takeaways

There are four notable takeaways from these developments:

The SEC's appointment of a "Crypto Czar" demonstrates that the agency is prioritizing cryptocurrency enforcement. Federal and state regulators are in the midst of a crypto industry sweep and it comes as no surprise that the SEC tapped an experienced insider to lead its cryptocurrency enforcement initiative. The SEC's appointment of a Crypto Czar demonstrates the agency's commitment to policing crypto-related activity and its expectation that enforcement activity will increase—in a more coordinated manner—in the months to come.  It should be noted that while the DOJ has yet to anoint its own crypto czar, it does have a crypto-crimes point person:  Digital Currency Counsel Michele Korver.

The SEC is actively investigating both companies and individuals for ICO misconduct, and is particularly concerned about fraudulent activity. The TBIS enforcement action—which comes hot on the heels of the Centra Tech, Inc. and RECoin matters—is further evidence that the SEC is still actively investigating and policing ICO activity. In all three cases, the SEC accused the defendants of a number of securities law violations, including misleading investors. In the RECoin matter, the SEC accused the defendants of falsely representing that the business venture was "led by an experienced team of brokers, lawyers and developers" when there was only one employee. In the Centra Tech, Inc. matter, the SEC accused the defendants of touting non-existent relationships with credit card companies, fabricating the identity of a CEO and leveraging paid celebrity promotions. In the TBIS enforcement action, the SEC alleged the defendants posted false testimonials on their website and lied‎ about connections to prominent businesses and the Federal Reserve Bank.

In many ways, these cases represent‎ old wine in new bottles; while the technology may be novel, the schemes—such as the use of material misrepresentations and omissions to mislead investors—are familiar. As a result, the SEC is operating on well-trodden ground.

The SEC has offered a clue on how it might be differentiating between security tokens and non-security utility tokens. Buried in paragraph 44 of the TBIS complaint, the SEC writes that "[a]lthough BAR was characterized in the TBIS whitepapers as a 'utility token,' it did not have any functionality at the time of the ICO (nor does it currently), and was sold as an investment." The SEC appears to be distinguishing between tokens that have functionality at the time of their offer and sale and those that do not, suggesting perhaps that if the token has functionality on an existing digital platform at the time that it is offered or sold, it might qualify as a separate asset class. Whether this distinction opens the doors to arguments that ‎utility tokens are not subject to securities regulation remains an open question. While such a distinction would be welcome news to the blockchain and cryptocurrency industries eager for a bright-line rule to navigate a legal grey zone, the facts as alleged in TBIS suggest that this case will not hinge on the question of whether the BAR/TBAR tokens qualify as utility tokens.

As a result, those operating in this arena must continue to rely on guidance in SEC speeches and public statements, which has ranged from SEC Chairman Jay Clayton's "I believe every ICO I've seen is a security" claim in February 2018 to SEC Commissioner Hester Peirce's "I am wary of any blanket designation for all ICOs" comment in May 2018.  In a June 6, 2018 interview, Chairman Clayton maintained that "most" ICOs are securities, noting that if the ICO offers a return on investment, it is a security.  At the same time, he stated that cryptocurrencies that function as replacements for sovereign currencies are not securities. These recent statements suggest a retreat from the "one size fits all" approach to digital asset regulation.

While regulators are warming up to blockchain's potential and expressing a willingness to work with industry participants, they are persisting with enforcement fervor. CFTC Commissioner Behnam's recent remarks and those of other regulators suggest that they are entering an era of blockchain enlightenment. Commissioner Behnam lauded blockchain as "an advance that reaches out into every aspect of life [that could be used] to address the most basic, the most primal problems on our planet: corruption, income distribution, poverty, food, and health care." Meanwhile SEC Commissioner Peirce has suggested that such technology may assist with "capital formation, market efficiency, economic growth, and overall societal well-being." She suggested that the "best path forward is for regulators to approach ICOs and tokens with intense curiosity" and "put in the effort to learn about these new technologies." Chairman Clayton's June 6 remarks included an acknowledgement of the "incredible promise" and potential of blockchain technology to "drive efficiencies not only in financial markets but in a lot of markets." The CFTC and SEC's recognition of blockchain's promise may open the door to a more collaborative dialogue between regulators and the industry about regulating digital assets.

Whether this shift in perspective will ultimately affect enforcement strategies remains unknown but the CFTC and SEC continue to warn that they will not stand for fraud on their watch.  Commissioner Behnam noted that the CFTC has "enforcement jurisdiction to investigate fraud and manipulation in underlying virtual currency spot markets and, as appropriate, conduct civil enforcement actions where fraud or manipulation is found." Similarly, SEC Commissioner Peirce reminded her audience that "it is absolutely essential that we address securities law violations, in particular fraud, that occur in any market under our jurisdiction." Market participants should continue to proceed with caution and remain focused on regulatory requirements.

Deborah R. Meshulam is a partner at DLA Piper and a former assistant chief litigation counsel in the SEC's enforcement division.  Benjamin D. Klein is a senior associate at DLA Piper and a former international prosecutor.  Richard Kelley is an associate at DLA Piper.