With the meteoric rise of virtual currencies and lack of regulatory updates by Congress to regulate same, various federal agencies (e.g., IRS, Treasury Department, FBI, and SEC) have been trying to fill the gaps and claim concurrent jurisdiction. The most well-known example is the Securities and Exchange Commission (“SEC”); however, even the SEC has struggled to provide clear guidance and struggles with determining what tokens do and do not constitute a security (e.g., XRP or Ripple). With regulators and Congress in flux, a lesser-known agency to the general public is appearing to take the reins in the name of protecting markets and it’s the U.S. Commodity Futures Trading Commission (“CFTC”). This article will breakdown the who, what, when, where, and how with regard to CFTC enforcement over cryptocurrencies.
Who is the CFTC? The CFTC is a federal agency located in offices around the country that primarily regulates commodity derivatives contracts that are based on underlying commodities. While its regulatory oversight authority over commodity cash markets is limited, the CFTC maintains general anti-fraud and manipulation enforcement authority over virtual currency markets as a commodity in interstate commerce. Its authority power is wielded using the Commodity Exchange Act (“CEA”), 7 U.S.C. § 1 et seq., and other CFTC regulations, Title 17 of the Code of Federal Regulations.
What tokens are considered a commodity? All virtual currencies have been deemed a commodity. The CEA statutory definition of a commodity is broad. Not only has the CFTC deemed virtual currencies commodities but federal courts have agreed as well. In CFTC v. McDonnel et al., Case No. 18-CV-00361 (E.D.N.Y. March 6, 2018), a federal court held that (1) the CFTC may regulate all virtual currencies as a commodity and furthermore, (2) the CFTC has jurisdiction over fraud under the CEA whether futures and derivative contracts are involved or not. Prior to this decision, the CFTC made it clear that it is taking a role in enforcement concurrently with other federal agencies. See Chairman Giancarlo Statement on Virtual Currencies, CFTC, Jan. 4, 2018 (“One thing is certain: ignoring virtual currency trading will not make it go away. Nor is it a responsible regulatory strategy. The CFTC has an important role to play.”).
When does the CFTC take regulatory action? The process starts with the CFTC getting a tip, complaint, and/or referral from another agency. Upon receipt, the enforcement division will conduct a preliminary review. If further scrutiny is warranted, a formal investigation is opened which will involve the service of subpoenas and conducting voluntary interviews. Upon review of all information gathered, the enforcement division will present their findings to the subject(s) of the investigation to seek any rebuttal followed by a review by the commission to decide whether to settle or litigate.
Where does the CFTC take enforcement action? Pursuant to Title 7 U.S.C. § 13a-1(a), the CFTC may seek injunctive or other relief when it believes that a person or entity is in violation of the CEA. This means the CFTC will bring an action in a district court of the United States or administrative proceedings before an administrative law judge. Relief typically sought includes injunctive relief, monetary penalties, and restitution.
How does the CFTC seek regulatory relief? Based on cases brought to date, the CFTC seeks relief based on three main areas. First, the CFTC may bring a cause of action based on the failure to register with the CFTC. For example, many of the companies that have been targeted are groups of investors pooling funds in order to stake the funds and split any profits based on pro rata shares. Here, the CFTC claims such a group must be registered as a commodity pool operator along with an associated persons to such pool. Second, the CFTC may bring a cause of action based on misrepresentations. In other words, the CFTC will look to see whether the representations made by cryptocurrency companies are conducting business as agreed. Finally, the CFTC may bring a cause of action based on misappropriation; meaning has the cryptocurrency company misappropriated or stolen any investor funds.
Whether you operate a cryptocurrency company or if you are an investor involved in cryptocurrency markets, it is important to understand the CFTC’s role in the current regulatory scheme. If you operate or own a company, you need to be aware of the CFTC’s licensure requirements and have sufficient policies and procedures in place to prevent misappropriation by bad actors or insider threats. Similarly, if you are an investor, it is important to know that the CFTC is an option when funds are stolen or a company misrepresents its intentions or becomes non-responsive. This firm has represented clients on both sides and can provide assistance in navigating the ever-changing cryptocurrency regulatory environment.