SEC and CFTC Charge Non-US Trading Platform with Selling Unregistered Security-Based Swaps and Failing to Register as a Futures Commission Merchant

Practical Law Legal Update w-022-7394 (Approx. 5 pages)

SEC and CFTC Charge Non-US Trading Platform with Selling Unregistered Security-Based Swaps and Failing to Register as a Futures Commission Merchant

by Practical Law Finance

SEC Order

According to the SEC order, FGC offered and sold SBS including FGC's bitcoin Asset Linked Notes (bALNs), through a website. The investments were marketed to US-based retail investors, and although FGC posted disclaimers indicating that US investors were restricted from having accounts, the FGC did not enforce them. Since investors were required to provide know-your-customer (KYC) information to open an account, FGC was aware of the residency of all of its investors. FGC did not require investors to meet certain asset or income thresholds in order to engage in trading activity.

FGC offered the following three types of accounts:

Competition accounts, which were awarded to a limited number of traders and included a trading credit that was measured in bitcoin.
Direct accounts, into which investors deposited bitcoin and made trades based on the value of their bitcoin in deposit.
Self-employed trading accounts, into which investors entered into an agreement with FGC to deposit bitcoin and then engaged in trading activity as an independent contractor with FGC.

The SEC order stated that:

US-based investors comprised more than 25% of FGC's traders.
24 of the 90 FGC investors that conducted trades in SBS and/or commodities were US residents.
US resident traders accounted for more than 50% of the value of trades from self-employed trading accounts, and more than 16% of the value of trades from direct accounts.
Between 2014 and 2019, over $120 million worth of SBS based on US-listed securities were bought and sold by traders with one of the three types of FGC accounts, with over $43 million of trades made by US resident traders.

However, according to the order, none of the US residents who purchased the SBS at issue qualified as eligible contract participants (ECPs). Section 6(1) of the Exchange Act prohibits the offer and sale of unregistered SBS to persons who are not ECPs, unless the transaction occurs on a registered national securities exchange (see Practice Note, US Derivatives Regulation: Swap Clearing and Trade Execution: Non-ECP Exchange-Trading Requirement). Under the ECP definition, individuals must have at least $5 million and often $10 million invested on a discretionary basis to qualify as an ECP (see 7 U.S.C. § 1a(18) and Practice Note, US Derivatives Regulation: The Eligible Contract Participant (ECP) Requirement for OTC Derivatives and Implications for Secured Lending: Requirements for ECP Status).

According to the SEC order, FGC violated:

Section 5(e) of the Securities Act and Section 6(1) of the Exchange Act because:
- the transactions were not executed with ECPs;
- no registration statements were in effect; and
- the contracts were not effected on a national securities exchange.
Section 15(a) of the Exchange Act by acting as an unregistered dealer on every SBS transaction.

The SEC ordered FGC to cease and desist from the securities violations and to pay over $130,000 in disgorgement and civil penalties. The SEC order notes that FGC cooperated with the investigation and promptly engaged in remedial efforts that included repayment of trading losses to US based investors.

The SEC issued a press release on the order.

For more information on the SEC's statements, guidance, and actions related to digital assets, see Practice Note, Understanding the SEC's Digital Asset Framework and Approach to Digital Asset Regulation.

For more information on the regulation of blockchain-based businesses generally, see Blockchain Toolkit.

CFTC Order

On October 31, 2019, the CFTC also filed and settled charges against FGC for violating Section 4d(a)(1) of the CEA by failing to register as an FCM. The CEA defines an FCM as a person that is "engaged in soliciting or accepting orders for the purchase or sale of a commodity for future delivery" or in connection with accepting "any money, securities, or property (or extend[ing] credit in lieu thereof) to margin, guarantee, or secure any trades that result or may result therefrom" (7 USC § 1a(28)).

According to the CFTC order, between March 2016 and July 2017, FGC:

Solicited customers, including US customers, to engage in commodity futures contracts such as the 10-Year Treasury Note and the E-Micro Gold futures. Trades that occurred on FGC's platform were settled in bitcoin.
Solicited or accepted orders from customers in contracts listed on the Chicago Mercantile Exchange (CME) Globex trading platform, requiring customers to:
- submit know-your-customer (KYC) information and documents; and
- deposit bitcoin into a bitcoin wallet controlled by FGC.
Instructed customers on its website to enter orders using bitcoin as margin collateral and, according to its website, would "arrange a loan to cover the margin needed to place the trade."
Charged financing fees and a commission per trade.

The CFTC found that FGC violated the CEA by acting as an FCM without registering with the CFTC.

The CFTC ordered FGC to:

Cease and desist from future violations of the CEA.
Pay a $100,000 fine in civil monetary penalties and disgorgement.

The CFTC order noted that FGC's cooperation with the investigation was reflected by a "substantially reduced" civil monetary penalty.

The CFTC also issued a press release on the order.

SEC and CFTC Charge Non-US Trading Platform with Selling Unregistered Security-Based Swaps and Failing to Register as a Futures Commission Merchant | Practical Law