During the period starting on January 19, 2018, and ending on March 2, 2018, the blockchain industry worldwide reported the following legal news:
- SEC: The Securities and Exchange Commission (the “SEC”) has launched a probe by issuing a number of subpoenas, reportedly approximately 80, to firms and individuals in the virtual currency and blockchain industry, including issuers, advisors as well as exchanges and purchasers concerning token sales, a.k.a ICOs (“TS”). Based on industry sources, these subpoenas seek information including “lists of investors, emails, marketing materials, organizational structures, amounts raised, the location of the funds and the people involved and their locations.” For example, it has been reported that the SEC subpoenaed TechCrunch, a cryptocurrency investment fund. Michael Arrington, the fund’s founder confirmed the subpoena stating: “We received a subpoena. Every [crypto]fund I've talked to has received one.” Also, Overstock.com, Inc. revealed in its Form 8-K filing on March 1, 2018, that it is under investigation concerning its tZero TS. According to the filing, “[i]n February 2018, the Division of Enforcement of the SEC informed the Company that it is conducting an investigation…and requested that the Company voluntarily provide certain documents related to the Offering and the Tokens in connection with its investigation.” It stated that it will cooperate with the SEC and stressed that “[w]hile the SEC is trying to determine whether there have been any violations of the federal securities laws, the investigation does not mean that the SEC has concluded that anyone has violated the law. Also, the investigation does not mean that the SEC has a negative opinion of any person, entity, or security.” The SEC has not yet commented on these actions.
On February 21, 2018, the SEC issued a statement and interpretive guidance on public company cybersecurity disclosures. Following the CF Disclosure Guidance Topic No. 2 regarding disclosure obligations concerning cybersecurity risks and incidents, the SEC now aims to provide further guidance addressing also “the importance of cybersecurity policies and procedures and the application of insider trading prohibitions in the cybersecurity context.”
According to the guidance, companies have an obligation to consider “the material of cybersecurity risks and incidents” when preparing disclosure documents required under the securities laws. In addition to any information expressly required, “a company is required to disclose ‘such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.’” According to the guidance, the materiality of cybersecurity risks or incidents is based on “their nature, extent, and potential magnitude, particularly as they relate to any compromised information or the business and scope of company operations…[as well as] the range of harm that such incidents could cause.”
Additionally, the SEC “encourage[s] companies to adopt comprehensive policies and procedures related to cybersecurity and to assess their compliance regularly, including the sufficiency of their disclosure controls and procedures as they relate to cybersecurity disclosure.” According to the interpretive guidance, “[c]ontrols and procedures should enable companies to identify cybersecurity risks and incidents, assess and analyze their impact on a company’s business, evaluate the significance associated with such risks and incidents, provide for open communications between technical experts and disclosure advisors, and make timely disclosures regarding such risks and incidents.”
The SEC also addresses the issue of insider trading stressing that “information about a company’s cybersecurity risks and incidents may be material nonpublic information, and directors, officers, and other corporate insiders would violate the antifraud provisions if they trade the company’s securities in breach of their duty of trust or confidence while in possession of that material nonpublic information.”
Finally, the guidance makes it clear that the SEC expects companies to incorporate such “policies and procedures” so that they can “ensure that any disclosures of material nonpublic information related to cybersecurity risks and incidents are not made selectively.”
-CFTC: On February 2, 2018, the Commodity Futures Trading Commission (the “CFTC”) issued an official statement advising investors to “be cautious” of virtual currency offerings claiming to have been approved for individual retirement accounts (“IRA”) or endorsed by the U.S. Internal Revenue Service (the “IRS”). The agency stated that “[t]axpayers tend to focus on retirement savings more at tax time in order to increase deductions or maximize savings. As a result, some businesses may attempt to lure customers into buying highly volatile cryptocurrencies using false claims or by painting virtual currencies as less risky because they can be used for retirement saving.” The CFTC reiterated that neither the IRS, CFTC nor any other federal agency reviews or endorses investments for IRAs or offers any investment advice. The agency also noted the particular risks associated with cryptocurrency investing and advised investors to protect themselves from Ponzi schemes and other fraudulent conduct.
On February 15, 2018, the CFTC issued a Customer Protection Advisory, warning investors about cryptocurrency “pump-and-dump” schemes. “Customers should not purchase virtual currencies, digital coins, or tokens based on social media tips or sudden price spikes. Thoroughly research virtual currencies, digital coins, tokens, and the companies or entities behind them in order to separate hype from facts.” The agency warns about an “old scam, new technology” practice, under which “[t]he same basic fraud is now occurring using little known virtual currencies and digital coins or tokens.” The Advisory describes some of the practices employed: “Some pump and dumps use false news reports, typically about a famous high-tech business leader or investor who plans to pour millions of dollars into a small, lesser known virtual currency or coin. Other fake news stories have featured major retailers, banks, or credit card companies, announcing plans to partner with one virtual currency or another. Links to the phony stories are also accompanied by posts that create false urgency and tell readers to buy now.”
- Hearing before the U.S. Senate Committee on Banking, Housing, and Urban Affairs: On February 6, 2018, the U.S. Senate Committee on Banking, Housing and Urban Affairs conducted an open session hearing entitled, “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission.” U.S. SEC Chairman Jay Clayton and U.S. CFTC Chairman J. Christopher Giancarlo were the witnesses providing testimony to the Committee.
SEC Chairman Clayton essentially reiterated the positions that the SEC has taken in its previous actions and statements. He urged caution for Main Street investors with respect to the risks involved in cryptocurrency investing, noting that due to international structure of transactions spanning across national borders “[i]nvestors’ funds may quickly travel overseas without their knowledge,” amplifying in that way relevant risks, “including the risk that U.S. market regulators, such as the SEC and state securities regulators, may not be able to effectively pursue bad actors or recover funds.” He went on to state that many tokens offered for sale in a TS fit the legal definition of a “security” under U.S. federal and state securities laws, and so these laws do apply to these transactions. He also noted that “to date no [TS] ha[s] been registered with the SEC.” (While this is indeed an accurate statement, it does not address the fact that many TS sponsors have and do take the proper steps to avail themselves of the various registration exemptions available under such securities laws, most notable Regulation D under the U.S. Securities Act of 1933.)
Chairman Clayton also discussed cryptocurrency trading markets, stating that “many of the U.S.-based cryptocurrency trading platforms have elected to be regulated as “money-transmission services,” which are mostly “state-regulated payment services” and as such not “subject to direct oversight by the SEC or the CFTC.” He further noted that “simply calling something a ‘currency’ or a currency-based product does not mean that it is not a security.” In fact, “financial products that are linked to underlying digital assets, including cryptocurrencies, may be structured as securities products subject to the federal securities laws even if the underlying cryptocurrencies are not themselves securities.”
For TS transactions, the SEC Chairman stated the primary question should be: “Is the coin or token a security?” He observed that the TS that he has seen involve “the offer and sale of securities and [so] directly implicate the securities registration requirements and other investor protection provisions” of federal law. As the agency had stated in its recent cease-and-desists order issued against Munchee Inc. Clayton noted that “[m]erely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” He concluded his testimony by summarizing the SEC’s relevant enforcement actions and confirmed that its enforcement division monitors vigorously TS for violations and collaborates with the CFTC in detecting fraud and abuse.
CFTC Chairman Giancarlo testified that his agency determined in 2015 that virtual currencies are “commodities” under the U.S. Commodity Exchange Act, thereby subjecting virtual currency derivatives to CFTC oversight. He cautioned, however, that the CFTC nevertheless does not have “regulatory jurisdiction over markets or platforms conducting cash or ‘spot’ transactions…For such virtual currency spot markets, [the] CFTC only has enforcement jurisdiction to investigate and, as appropriate, conduct civil enforcement action against fraud and manipulation.”
After discussing the potential benefits of blockchain technology and stating that “‘Do no harm’ was unquestionably the right approach to development of the Internet,” Chairman Giancarlo concluded his testimony with “I believe that ‘do no harm’ is [also] the right overarching approach for distributed ledger technology.”
-Wyoming: On March 6, 2018, House Bill 70, the “Open blockchain tokens-exemptions,” exempting certain tokens from the state’s securities laws, was passed by the Wyoming Senate with a vote of 27-3. The bill was unanimously passed by the House of Representative on February 20, 2018. Additionally, the Wyoming legislature passed four more bills related to blockchain; HB 19 (bitcoin bill) exempting virtual currencies from the Wyoming Money Transmitter Act, HB 101 (electronic corporate records bill) authorizing corporations to use electronic networks or databases for the creation or maintenance of corporate records as well as the use of a data address to identify a corporation’s shareholder and to accept shareholder votes, HB 126 (Limited Liability Companies series bill) and SF 111 (property taxation-digital currencies) exempting virtual currencies form property taxation. The bills are currently waiting to be signed by Wyoming Governor Matt Mead.
- Texas: On February 2, 2018, the State Securities Board of the State of Texas (the “TSSB”) entered an Emergency Cease-and-Desist Order against DavorCoin, alleging violations of the Texas securities law. DavorCoin operated a cryptocurrency lending platform similar to BitConnect, which had already ceased operations in January 2018 after having received its own TSSB Cease-and-Desist Order. Purchasers of “davorcoin” were told by DavorCoin that they could “start lending” davorcoin to the company “earn monthly interest rate up to 48%” through that lending activity. DavorCoin specifically represented that “an investor lending $30,000.00 in davorcoin who elects a ‘Locking period’ of 120 days may earn $513.00 per day, $3,591.00 per seven days, $15,390.00 per 30 days and $107,217.00 as of the 'capital release day.'”
In its Order, the TSSB determined that DavorCoin’s violated Texas law by offering unregistered securities for sale and not being “registered with the [Texas] Securities Commissioner as a dealer or agent at any time” violating Section 12 of the Texas Securities Act. The TSSB also concluded that the company engaged in fraud and misleading conduct “likely to deceive the public” and “threaten[ing] immediate and irreparable public harm.”
On January 24, 2018, the TSSB issued an Emergency Cease-and-Desist Order against R2B Coin, a Hong Kong-based firm, alleging violations of Texas securities law by promoting investment opportunities in r2b coin during a “pre-trade sales period” and “recruiting investors…[while referring to them] as sales agents as affiliates and pay[ing] commissions… in accordance with their position in multi-level marketing matrixes.” R2B Coin also claimed that public trading would commence once it “sets its price at $188.00 per coin,” that it “expects r2b coin to increase in price from $188 per coin to $200 per coin within the three months after the start of public trading,” and that “it will secure a listing for stock on the Seng Exchange in Hong Kong, the NASDAQ in New York or London Stock Exchange, and [that] investors may swap their 2rb coin for stock.”
In response, the TSSB alleged violations for non-registration of the transaction and its so-called “agents and affiliates” under the Texas Securities Act similar to that in DavorCoin.
- BitConnect: After the Cease-and-Desist Orders issued by the TSSB and the North Carolina Department of Secretary of State, a class action complaint was filed on January 29, 2018, in the United States District Court Western District of Kentucky against BitConnect International, PLC, BitConnect LTD and BitConnect Trading, LTD (collectively, “BitConnect”) and Ryan Maasen alleging “financial losses suffered from an online investment scam” due to the acts of BitConnect in operating “both a pyramid scheme and a Ponzi scheme.” According to the complaint, BitConnect made various unlawful representations, including that its tokens “would produce average yearly returns of 3,000%.” The class action complaint alleges that BitConnect and Maasen violated the U.S. federal and Kentucky state securities laws by offering and selling unregistered securities and failing to register as a “broker-dealer” or “agent” (respectively), as well as fraud violation of Kentucky Consumer Protection Act.
Following the commencement of this private party lawsuit, the presiding judge issued a Temporary Restraining Order was issued on January 30, 2018 freezing BitConnect’s and Maasen’s respective assets and requiring them to disclose “(a) all Bitcoin and other cryptocurrency wallet addresses, (b) all cryptocurrency trading account addresses, and (c) the identity of the holder/owner of any wallet or cryptocurrency address to which [they] have transferred any Bitcoin or other cryptocurrency … so that these assets can be monitored and traced.”
- New Jersey: On February 9, 2018, the New Jersey Bureau of Securities (the “Bureau”) issued a Cease-and-Desist Order against Bitstrade alleging violation of registration requirements under New Jersey law and fraudulent omissions of material facts. According to the Order, Bitstrade offered “to the general public, including New Jersey residents” “an investment pool whereby it collects ‘multiple lower value investments and grouping them into one single HUGE investment using those funds to trade on the stock market, and generate outstanding returns.’” The determined the Bitstrade investment to be a security under New Jersey’s securities laws that it was “neither registered with the Bureau [n]or exempt from registration,” and so in violation of those laws and also that Bitstrade unlawfully failed to register as a broker-dealer under New Jersey law. The Bureau also claimed that Bitstrade engaged in fraudulent conduct and with material misrepresentation and omissions in its disclosure documents.
- California: On February 16, 2018, Assembly Member Ian Calderon submitted a bill in the California legislature. The bill proposed the amendment of the Uniform Electronic Transactions Act expanding the definition of “electronic record,” “electronic signature” and “contract” in order to include records and signatures on the blockchain as well as smart contracts.
- Illinois: On January 31, 2018, the State of Illinois issued its first Blockchain Task Force Report following the creation of the Illinois Blockchain Initiative on November 30, 2016. In its Report the Blockchain Task Force states that: “This Task Force believes that blockchain technology and its built-in encryption can facilitate highly-secure methods for interacting with government and keeping paperless records, increasing data accuracy and providing better cybersecurity protections for Illinois residents. Though the technology still needs refinement, government has an opportunity to help shape and adopt innovative solutions.”
- Tennessee: On January 30, 2018, a new bill was introduced in the Tennessee legislature that would prohibit the trustees of any defined contribution plan or related investment vehicle established as a health benefit by any Tennessee insurance company from investing in any cryptocurrency.”
- Hawaii: On January 24, 2018, two bills were introduced in the Hawaiian State Senate defining a “virtual currency” to be within the meaning and scope of Hawaii’s Money Transmitters Act and requiring a license before engaging in transmissions of virtual currency in the state. The bills would also mandate that certain disclosures be provided by holders of such licensees to consumers before entering into any agreement to perform any virtual currency transmission services on their behalf.
On February 28, 2018, the Central Bank of Nigeria (the “CBN”) issued a press release repeating its warning against cryptocurrency investments. Digital currencies are not legal tender in Nigeria and cryptocurrencies and exchanges are neither licensed nor regulated by the CBN. According to the press release, “dealers and investors in any kind of crypto currency in Nigeria are not protected by law;” virtual currency exchange platforms worldwide are unregulated and, therefore, consumers may “lose their money without any legal redress.”
On March 1, 2018, Mexico’s lower house of Congress approved a bill regulating financial technology, including cryptocurrency firms. The bill, which was approved by the Mexican Senate in December, in now awaiting the signature of President Enrique Pena Nieto in order to go into effect. Financial stability and money laundering prevention are the primary aims of the bill. Additionally, it will increase “regulatory certainty around issues such as crowdfunding, payment methods and rules surrounding cryptocurrencies.” The law also includes a provision for open banking, which, according to Francisco Mere, President of the association Fintech Mexico, “recognizes that the information in the hands of the financial institutions is property of the user, not the institution’s, and that it can be brought to other financial intermediaries…allow[ing] better services, better costs and more inclusion.” Following the bill, secondary laws determining key details will soon be drafted by the regulators.
On February 16, 2018, the Swiss Financial Market Supervisory Authority (the “FINMA”) published guidelines regarding TS and the applicability of financial market regulations. The fundamental principal is that “each case must be decided on its individual merits;” a case-by-case determination is necessary as financial market regulations are not applicable to all TS. When assessing TS, FINMA “will focus on the economic function and purpose of the tokens,” with the key factors being “the underlying purpose of the tokens and whether they are already tradeable or transferable.” FIMNA identifies three token categories with the possibility of hybrid forms; payment tokens which “have no further function or links to other development projects,” utility tokens “which are intended to provide digital access to an application or service” and asset tokens which “represent assets such as participations in real physical underlyings, companies, or earning streams, or an entitlement to dividends or interest payments.” Additionally, FINMA states that anti-money laundering and securities regulations are mostly applicable for TS. Anti-money laundering regulations apply to payment TS and securities regulations apply to asset TS but not to payment TS. The issue arises concerning “utility” TS. According FINMA, “[t]hese tokens do not qualify as securities only if their sole purpose is to confer digital access rights to an application or service and if the utility token can already be used in this way at the point of issue.” However, “[i]f a utility token functions solely or partially as an investment in economic terms, FINMA will treat such tokens as securities.”
As FINMA CEO Mark Branson, stated, “[t]he application of blockchain technology has innovative potential within and far beyond the financial markets. However, blockchain-based projects conducted analogously to regulated activities cannot simply circumvent the tried and tested regulatory framework. Our balanced approach to handling [TS] projects and enquiries allows legitimate innovators to navigate the regulatory landscape and so launch their projects in a way consistent with our laws protecting investors and the integrity of the financial system.”
On February 1, 2018, the European Commission (the “EC”) announced the launching of the EU Blockchain Observatory and Forum, which aims to encourage the European market, including governments, different industries, and citizens “to seize new opportunities offered by blockchain, build expertise and show leadership in the field.” In taking this action, EC Commissioner for the Digital Economy and Society Mariya Gabriel stated that she sees "blockchain as a game changer and I want Europe to be at the forefront of its development. We need to establish the right enabling environment - a Digital Single Market for blockchain so that all citizens can benefit, instead of a patchwork of initiatives. The EU Blockchain Observatory and Forum is an important step in that direction.”
On February 12, 2018, the European Supervision Authorities (the “ESAs”) for securities, banking, and insurance and pensions issued a collective warning to consumers about the high risks of virtual currencies. The ESAs stressed that there is extreme volatility and bubble risk when buying virtual currencies and, therefore, purchasers could “lose a large amount, or even all, of the money invested.” Additionally, the absence of protection is a significant concern. Virtual currencies, virtual currency exchanges and digital wallets are unregulated under EU law and therefore consumers cannot “benefit from any protection associated with regulated financial services. For example, if a VC exchange goes out of business or consumers have their money stolen because their VC account is subject to a cyber-attack; there is no EU law that would cover their losses.” The warning also refers to the lack of exit options and the lack of price transparency as well as the risk of misleading, incomplete information that fail to accurately disclose all risks associated with such virtual currencies. Finally, the ESAs highlight the operational disruptions that have been recorded in virtual currency exchanges. “During these disruptions, consumers have been unable to buy and sell VCs when they wanted to and have suffered losses due to price fluctuations during the period of disruption.” The ESAs advise potential virtual currency purchasers to “fully understand their characteristics and the risks” related and to only invest money they “afford to lose.”
On January 29, 2018, the German Financial Supervisory Authority (the “BaFin”) issued a Cease-and-Desist Order against a Berlin-based exchange, Crypto.exchange GmbH “to immediately cease its bitcoin brokerage services” due to its lack of requisite legal authority to perform such activities in Germany.
On February 20, 2018, the BaFin issued guidance on whether tokens sold during a TS should be considered financial instruments. BaFin does not plan to issue broad, general rules regulating such activity. Instead, it supports a “precise case-by-case examination” regime in order to determine the legal status of such tokens as “tokens can represent various financial instruments, including stocks, derivatives and digital representations of voting rights.”
On February 4, 2018, the Securities and Commodity Authority (the “SCA”) of the United Arab Emirates issued a warning about digital, token-based fundraising activities. According to SCA, cryptocurrency investing carries significant risk based on the relative lack of governmental regulation and the uncertainty around the application of foreign laws and, thus, “[t]racking and recovering funds in case of [TS] collapse may prove to be extremely difficult in practice.” Additionally, fraud, volatility, as well as unaudited and incomplete information and the potential for misleading representations pose further risks to cryptocurrency investors. The SCA reiterated that “it does not recognize, regulate, or supervise any [TS] presently and that [TS] investments are not offered legal or regulatory protection.” Therefore, people participating in such TS “are doing so at their own risk.”
On February 1, 2018, the Ontario Securities Commission announced that it had approved Canada’s first blockchain exchange-traded fund, HBLK, which Harvest Portfolio Group Inc. launched on the Toronto Stock Exchange in February. HBLK’s stated purpose is to invest “in equity securities of issuers exposed, directly or indirectly, to the development and implementation of blockchain and distributed ledger technologies.”
The Commissioner of the Philippines Securities and Exchange Commission (the “PSEC”) recently announced that it is developing rules regarding cryptocurrency transactions. During a news conference held on January 29, 2018, Commissioner Emilio Aquino said that the relevant regulations will be finalized during 2018. He noted some urgency in stating that: “We need to act because initial coin offerings are sprouting [and we] want to come up with our own set of regulations.”
Please contact Alexandra Levin Kramer, the Chair of CKR Law’s Blockchain Technology & Digital Currency practice group if you have any questions. She can be reached at email@example.com or +1 (212) 259-7300.
 Commission Statement and Guidance on Public Company Cybersecurity Disclosure (Feb, 21, 2018), https://www.sec.gov/rules/interp/2018/33-10459.pdf
 SEC Press Release 2018-22, https://www.sec.gov/news/press-release/2018-22
 CF Disclosure Guidance: Topic No. 2 – Cybersecurity, https://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic2.htm
 Commission Statement and Guidance on Public Company Cybersecurity Disclosure, supra note 4, at 6.
 Id., at 7.
 Id., at 10.
 Id., at 18.
 Id., at 20.
 Id., at 21.
 Id., at 22-23.