Yesterday, the Commodity Futures Trading Commission brought an enforcement action against the operators of an alleged Ponzi scheme who, according to the allegations, collected approximately $600,000 from 80 investors in a pooled fund to invest in bitcoin under a high-frequency, algorithmic trading strategy. The operators instead allegedly misappropriated the funds and fabricated a hack to hide the losses.
This activity, as described, constitutes garden variety fraud within the scope of the CFTC’s anti-fraud authority over commodity markets. But the enforcement action is, as noted in the CFTC’s press release, the first time the CFTC has used the relatively new anti-fraud authority granted to it by Dodd-Frank against activities in the virtual currency market. The enforcement action is noteworthy in a few other respects:
- The CFTC’s watchful eye on virtual currency markets. The action makes clear that the CFTC is closely monitoring virtual currency markets, not only markets in derivatives on virtual currencies. CFTC Chair Giancarlo recently praised the potential of blockchain technology but also stated that “current enthusiasm for certain cryptocurrencies shouldn’t blind investors and regulators to the many risks that are evolving in this space.”
- Implications for non-security ICO tokens and other digital assets. The SEC has recently focused on the status of digital asset tokens as securities and the regulation of initial coin offerings (ICOs) as security offerings. As highlighted by this enforcement action, even where tokens do not constitute securities, transactions in and activities involving tokens are likely subject to the CFTC’s anti-fraud jurisdiction on the basis that non-security tokens or other digital assets are commodities for purposes of the Commodity Exchange Act. The CFTC’s anti-fraud rules contain a similar prohibition against material misstatements or omissions as that contained in SEC Rule 10b-5 under the Securities Exchange Act. Given criticism of the sufficiency of ICO disclosures, ICO promoters and their counsel should consider the potential for the CFTC or aggrieved investors to bring action under the CFTC rules.
- Overlapping anti-fraud enforcement jurisdiction. The SEC has recently brought enforcement actions similar to this CFTC action, for example SEC v. Shavers. Particularly where alleged fraud involves collective investment schemes and virtual currencies, both the SEC and CFTC are likely to have overlapping anti-fraud jurisdiction
- Enforcement coordination with LabCFTC? The CFTC’s press release raises questions about how closely the CFTC’s enforcement division may be coordinating with the newly established LabCFTC. The press release states that “aggressively and assertively” rooting out fraud and bad actors in these areas demonstrates the agency’s “continued commitment to facilitating market-enhancing FinTech innovation,” as exemplified by LabCFTC.
Key takeaway: Given the CFTC and SEC’s focus on virtual currencies and other digital assets, firms and individuals engaged in trading and facilitating transactions in these assets should consider taking steps to ensure that they do not run afoul of the agencies’ anti-fraud provisions. For example, because many employees of virtual currency firms, or consultants working for those firms, trade in virtual currencies themselves, these firms or the individual traders could be at risk of violating CFTC anti-fraud insider trading restrictions if they misuse material non-public information obtained from their employers. Firms should consider adapting traditional compliance principles developed to address SEC and CFTC anti-fraud and anti-manipulation rules to virtual currency activities.