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SEC and CFTC Issue Statements on Cryptocurrencies and Initial Coin Offerings
Practical Law Legal Update w-012-4123 (Approx. 6 pages)
SEC and CFTC Issue Statements on Cryptocurrencies and Initial Coin Offerings
by Practical Law Finance
| Published on 29 Dec 2017 • USA (National/Federal) |
SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo issued statements providing general views on the cryptocurrency and initial coin offering (ICO) markets and addressing market concerns and considerations.
SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo issued statements providing general views on the cryptocurrency and initial coin offering (ICO) markets and addressing market concerns and considerations. These statements come as the cryptocurrency market continues to grow exponentially, with regulators looking to define their role.
The term "cryptocurrencies" is used by regulators to refer to virtual currencies such as bitcoin.
CFTC Statement
On January 4, 2018, the CFTC:
- Published a statement by Chairman Christopher Giancarlo on virtual currencies.
- Announced an upcoming meeting on January 31, 2018 to consider the process of self-certification of new products and operational rules by designated contract markets (DCMs) under the Commodity Exchange Act (CEA).
- Released a backgrounder on its oversight of and approach to virtual-currency futures markets, which includes:
- an overview of federal oversight of and jurisdiction over virtual currencies;
- the CFTC's approach to regulation of virtual currencies;
- details regarding the process of self-certification in general as well as specific details regarding the recent self-certification of new contracts for bitcoin futures products by DCMs;
- background on the CFTC's "heightened review" for virtual-currency contracts, which focuses on extensive visibility and monitoring of markets for virtual-currency derivatives and underlying settlement reference rates; and
- a discussion of the three major groups that the CFTC believes could be impacted by virtual-currency futures: market participants and consumers, public interest, and DCO clearing members.
Similar to the SEC statement (see SEC Statement), the CFTC statement recognized the significant opportunities and challenges underlying virtual currency, and highlighted the actions that the CFTC has been taking to enable fraud- and manipulation-free commodities trading, such as:
- Taking action against unregistered bitcoin futures exchanges.
- Enforcing laws prohibiting wash trading and prearranged trades on a derivatives platform.
- Issuing proposed guidance on what constitutes a derivatives market or spot market in the context of virtual currency (see Legal Update, CFTC Proposes Legal Interpretation of Actual Delivery Exception for Virtual Currency Regulation).
- Issuing warnings about valuations and volatility in spot virtual-currency markets (see Legal Update, LabCFTC Issues Primer on CFTC Regulation of Virtual Currencies).
- Addressing a bitcoin Ponzi scheme that fraudulently solicited participation in a pooled fund to trade bitcoins.
- Producing consumer information about virtual currencies, including:
- a dedicated bitcoin webpage;
- a virtual-currency primer (see Legal Update, LabCFTC Issues Primer on CFTC Regulation of Virtual Currencies); and
- several podcasts.
SEC Statement
On December 11, 2017, SEC Chairman Jay Clayton issued a statement providing a general view on the cryptocurrency and ICO markets and addressing concerns and considerations for investors and market professionals. This statement comes on the heels of a cease and desist letter served by the SEC to stop an ICO after the company failed to register certain ICO tokens as securities with the SEC.
"Cryptocurrencies" secured by cryptography rather than a central system administrator are designed to be items of inherent value that are intended to provide many of the same functions as long-established currencies without the backing of a government or other body. In theory, cryptocurrencies can provide:
- The ability to make transfers without an intermediary and without geographic limitation.
- Finality of settlement.
- Lower transaction costs compared to other forms of payment.
- The ability to publicly verify transactions.
- Personal anonymity and the absence of government regulation or oversight.
Recent growth in cryptocurrencies has led to an increase in ICOs to raise capital for projects. Typically, ICOs involve a chance for individual investors to exchange currency or cryptocurrencies in return for a digital asset labeled as a coin or token. According to the SEC, ICOs may involve the offer and sale of securities and therefore require securities registration and other investor protections under the federal securities laws.
According to the SEC statement, the SEC plans to police the area of cryptocurrencies and ICOs vigorously and recommend enforcement actions against ICOs that are offered in violation of federal securities laws. The SEC statement also cautions investors regarding:
- Minimized investor protections in the cryptocurrency and ICO markets, which can lead to more opportunity for fraud and manipulation.
- Unregistered ICOs.
- The fact that the SEC has not yet approved listing and trading any exchange-traded products that hold cryptocurrencies or other assets related to cryptocurrencies.
- SEC resources available for more information as well as a list of sample questions that may be helpful to ask before investing in cryptocurrency and ICO markets.
- Amplified risk due to the cross-border nature of the cryptocurrency and ICO markets.
Market participants are cautioned against promoting or touting an offer and sale of coins without first determining whether the securities laws apply to those actions. The SEC urges market participants to read and review the SEC's Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 ("21(a) Report") and subsequent enforcement actions. The 21(a) Report established that a particular ICO token constituted an investment contract and therefore was a security under our federal securities laws.
An investment contract is defined as "an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others." Since the "investment" is not limited to money and can be goods or services or some other exchange of value, an investment contract was created through the receipt of ICO tokens. The 21(a) Report was published to advise those using similar distributed ledger or blockchain-enabled methods for capital raising to take appropriate steps to ensure compliance with the US federal securities laws.
Subsequently, some market participants attempted to claim that their proposed tokens or coins were not securities by highlighting the utility characteristics of their proposed ICOs to show that the token for sale would be used to purchase a service and therefore was not a security that is subject to SEC registration. However, the SEC statement points out that "merely calling a token a 'utility' token or structuring it to provide some utility does not prevent the token from being a security."
Before launching a cryptocurrency or a product with value tied to cryptocurrency, its promoters must either:
- Be able to demonstrate that the currency or product is not a security.
- Comply with applicable registration and other requirements under US securities laws.
Additionally, brokers, dealers, and other market participants that deal in cryptocurrencies should exercise particular caution, including ensuring that their cryptocurrency activities are not undermining their anti-money laundering (AML) and know-your-customer (KYC) obligations.