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Memorandum

CFTC Charges Bitcoin Ponzi Scheme

October 30, 2017
Which Agency has Jurisdiction Over Virtual Currencies?

On October 17, 2017, the Commodity Futures Trading Commission ("CFTC") released a primer on digital currencies, in which it reiterated its position that virtual currencies are commodities.1 The CFTC has taken this position in a number of previous cases, most recently on September 21, 2017 when it charged Gelfman Blueprint, Inc. ("GBI") and its CEO and head trader (together, the "Defendants") with operating a virtual currency2 Ponzi scheme, in which the Defendants fraudulently solicited participation in a pooled fund that purportedly employed a high-frequency, algorithmic trading strategy to trade the virtual currency bitcoin, a commodity (the "GBI Enforcement Action").3 The CFTC alleged that the strategy was fake, the purported performance was false and payouts of supposed profits to investors in actuality consisted of other investors' funds. In addition, the CFTC alleges that the Defendants misappropriated investor funds to pay business expenses and enrich the CEO and fabricated a hack to explain the loss of its customers' investments. While previous enforcement actions focused on failures to register under the Commodities Exchange Act ("CEA"),4 this case marks the first CFTC anti-fraud action involving virtual currency. Section 6(c)(1) of the CEA gives the CFTC the power to enforce the provisions of the CEA against persons who employ fraud in connection with the contract of sale of any commodity.

          As discussed in a previous client alert (SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities, the CFTC is not alone in applying its existing regulations to operators of virtual currency investments. The Enforcement Division of the Securities and Exchange Commission ("SEC") has previously brought charges for failing to register a virtual currency-denominated stock exchange,
5 publicly offering the unregistered securities of two companies in exchange for virtual currency,6 and operating a Ponzi scheme in virtual currency.7 The SEC's recent DAO Report has established that the SEC will treat certain "coins" or "tokens" that are offered through an initial coin offering as a security.8 This means that actions by issuers of virtual currencies and their promoters could be subject to scrutiny by both the SEC and the CFTC for compliance with applicable laws, rules and regulations.

          The GBI Enforcement Action highlights the jurisdictional overlap between the CFTC and the SEC in the case of pooled investments in cryptocurrency. Although the enforcement action is the CFTC's first against an alleged operator of a Ponzi scheme in virtual currency, in 2013 the SEC charged the operator of a virtual currency-denominated investment pool with running a Ponzi scheme (styled SEC v. Shavers, the "Shavers Enforcement Action").
9 SEC enforcement actions have been based on the fact that the interests in the pool were securities and therefore the offer and sale of the security had to be registered, whereas the CFTC's GBI Enforcement Action focuses on GBI's alleged fraud in connection with contracts for the sale of a commodity.

Conclusion

          The regulation of virtual currencies is a developing area of the law as state and federal agencies seek to balance the need for regulation with the desire not to discourage innovation. Because a variety of state and federal agencies have asserted jurisdiction over virtual currencies, some of which is overlapping, operators of virtual currency investment opportunities should carefully consider whether their activities meet all applicable regulatory requirements.

          Seward & Kissel will continue to monitor any developments regarding regulatory treatment of virtual currency. If you have any questions regarding virtual currency or other issues in connection with virtual or cryptocurrencies, please contact one of the attorneys listed below or your Seward & Kissel contact attorney.

          For our previous updates and guidance on virtual currency and Initial Coin Offerings prepared by S&K, please refer to the following:

CFTC Considers Virtual Currency Derivatives to be Commodity Interests

SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities

 

Jim Cofer
(212) 574-1688
cofer@sewkis.com

Meir Grossman
(212) 574-1242
grossman@sewkis.com

David Mulle
(212) 574-1452
mulle@sewkis.com

Marlon Paz
(202) 661-7178
paz@sewkis.com

Christopher Riccardi
(212) 574-1535
riccardi@sewkis.com

Anthony Tu-Sekine
(202) 661-7150
tu-sekine@sewkis.com

______________________________________________________ 

  

  

1   A CFTC Primer on Virtual Currencies," released by LabCFTC, the CFTC's focal point for its efforts to promote responsible FinTech innovation and fair competition for the benefit of the American public.  Available at http://www.cftc.gov/idc/groups/public/documents/file/labcftc_primercurrencies100417.pdf.

2   The CFTC defines virtual currency as "a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction." This definition includes bitcoin.

3   CFTC v. Gelfman et al., No.17-7181 (S.D.N.Y Sept. 21, 2017), available at http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfgelfmancomplaint09212017.pdf.

4   The CFTC previously brought actions for operating an unregistered options exchange (In re Coinflip, Inc., CFTC No. 15-29 (Sept. 17, 2015), available at http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf),  failing to register as a futures commission merchant and offering certain prohibited off-exchange transactions (In re BFXNA Inc., CFTC No. 16-19 (June 2, 2016), available at http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf),  and engaging in illegal wash and prearranged trading In re TeraExchange LLC, CFTC No. 15-33 (Sept. 24, 2015) available at http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfteraexchangeorder92415.pdf).

5   In the Matter of BTC Trading Corp. and Ethan Burnside, Securities Act Release No. 9685 (December 8, 2017), available at https://www.sec.gov/litigation/admin/2014/33-9685.pdf.

6   In the Matter of Erik T. Voorhees, Securities Act Release No. 9592 (June 3, 2014), available at https://www.sec.gov/litigation/admin/2014/33-9592.pdf.

 

7   SEC v. Shavers, No. 13-416 (E.D. Tex. July 23, 2013), available at https://www.sec.gov/litigation/complaints/2013/comp-pr2013-132.pdf.

 

8   Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Act Release No. 81207 (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf.

 

9   SEC v. Shavers, No. 13-416 (E.D. Tex. July 23, 2013), available at https://www.sec.gov/litigation/complaints/2013/comp-pr2013-132.pdf.

 

______________________________________________________ 

 

If you have any questions regarding the matters covered in this memo, please contact any of the partners and counsel listed below or your primary attorney in Seward & Kissel's Investment Management Group.

 

 

John J. Cleary

cleary@sewkis.com 

(212) 574-1255

Maureen R. Hurley

hurley@sewkis.com 

(212) 574-1384

Paul M. Miller

millerp@sewkis.com 

(202) 737-8833

Joseph M. Morrissey

morrissey@sewkis.com 

(212) 574-1245

David R. Mulle

mulle@sewkis.com 

(212) 574-1452

Steven B. Nadel

nadel@sewkis.com 

(212) 574-1231

Anthony C.J. Nuland

nuland@sewkis.com 

(202) 661-7140

Marlon Q. Paz
paz@sewkis.com

(202) 661-7178

Patricia A. Poglinco

poglinco@sewkis.com 

(212) 574-1247

Christopher C. Riccardi

riccardi@sewkis.com 

(212) 574-1535

 

Jack Rigney

rigney@sewkis.com 

(212) 574-1254

John E. Tavss

tavss@sewkis.com 

(212) 574-1261

Robert B. Van Grover

vangrover@sewkis.com 

(212) 574-1205

 

Robert L. Chender

chender@sewkis.com

(212) 574-1415

Ivy Wafford Duke

duke@sewkis.com 

(202) 661-7179

Keri E. Riemer

riemer@sewkis.com 

(212) 574-1598

David Tang

tang@sewkis.com 

(212) 574-1260

______________________________________________________ 

 

About Seward & Kissel LLP

 

Seward & Kissel LLP, founded in 1890, is a leading U.S. law firm with an international reputation for excellence. We have offices in New York City and Washington, D.C.

Our practice primarily focuses on corporate, litigation and restructuring/bankruptcy work for clients seeking legal expertise in the financial services, corporate finance and capital markets areas.  The Firm is particularly well known for its representation of major commercial banks, investment banking firms, investment advisers and related investment funds (including mutual funds and hedge funds), master servicers, servicers, investors, distressed trade brokers, liquidity providers, hedge fund administrators,  broker-dealers, institutional investors and transportation companies (particularly in the shipping area).
 

 

Notices

 

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