A View from the Regulators: SEC, FINRA and CFTC Perspectives
Eileen Bannon and Jennifer Connors presenting at the Blockchain program.
On June 26, 2018, Partners Jennifer Connors and Eileen Bannon presented on how different regulators are viewing virtual currency.
Ms. Connors started by discussing the approach the SEC is taking when looking at ICOs (initial coin offerings). These transactions are often engaged in by promoters of digital networks looking to raise money to develop their networks. The SEC has applied the so-called "Howey Test" from the 1946 Supreme Court case SEC v. W.J. Howey Co. to the sale of the virtual currency by the promoters. This test provides that an investment contract exists, and thus a security has been created, where there is an investment of money in a common enterprise with a reasonable expectation of profits derived from the managerial efforts of others. In July 2017, the SEC issued the results of an investigative report, which found that the issuing of tokens such as bitcoin, XRP and Ethereum constituted investment contracts between the promoter and the purchaser of the token. As a result, these token would be deemed securities under federal securities laws and be able to be regulated by the SEC. In addition, if a platform offers trading of digital assets that are securities and operates as an exchange, then the platform must register with the SEC as a national securities exchange.
Ms. Connors pointed out that assets have the ability to change and morph over time. As digital networks that support the virtual currency mature and become more and more functional, the sale of the virtual currency would likely be seen less as an investment contract, and thus not deemed a security. The rationale for this is that the purchaser of the virtual currency is relying less on the managerial efforts of others to derive a profit. However, as it stands now, the SEC is able to at least attempt to regulate initial coin offerings. A recent example of this was the case of SEC v. Titanium Blockchain Infrastructure., et al., where the SEC sought and received an order in federal court halting an ICO that had raised approximately $21. The case involved allegations that the defendants provided false and misleading information regarding the services they were offering.
Ms. Bannon discussed regulation of virtual currencies by the Commodity Futures Trading Commission (CFTC). The CFTC regulates the commodities markets and derivatives referencing commodities, including futures and options. The CFTC brought its first enforcement action in 2015 against a platform offering options on bitcoin, and in the context of that proceeding held that virtual currencies are commodities. In March 2018, the Eastern District of New York affirmed the determination of the CFTC that virtual currencies are commodities. Accordingly, the CFTC has jurisdiction over fraud and manipulation in the virtual currency market and over platforms offering futures, options or other derivatives referencing virtual currencies. Ms. Bannon also discussed how the CFTC has jurisdiction under certain circumstances over platforms that offer virtual currencies on a margined basis to "retail" entities or persons. Ms. Bannon described the process by which certain platforms registered with the CFTC have "self-certified" futures and options referencing bitcoin for trading on their platforms, and compared this to the process of obtaining SEC approval for listing of ETF's referencing virtual currencies. Finally, Ms. Bannon described how the derivatives market is looking to use distributed ledger technology to simplify trade reconciliation and reporting.