One Pie, Many Slices: Recent Court Decisions Carve Up SEC and CFTC Jurisdiction in Virtual Currency

CFTC v. My Big Coin Pay, Inc.

In CFTC v. My Big Coin Pay, Inc., the defendants had moved to have the case dismissed on the ground that the definition of “commodity” under the CEA requires that the “good” or “article” at issue must be one “in which contracts for future delivery are presently or in the future contract dealt in.” As there is no futures market for MBC, the defendants argued it is not a “commodity” under the CEA. The court rejected that argument and instead held that the definition requires only that there be a futures contract in the “class” or “category” of goods in question, not the particular type or form. Pointing out that there are futures contracts on bitcoin, and satisfied that there are various characteristics common to virtual currencies, the court held that the CEA’s definition of commodity was met because the category in question is “virtual currency,” and MBC is a virtual currency.

The MBC decision builds on Judge Jack B. Weinstein’s March 2018 ruling in CFTC v. McDonnell (McDonnell) that virtual currencies are commodities under the CEA and therefore subject to the CFTC’s enforcement authority.⁶ Judge Weinstein found that virtual currencies “are ‘goods’ exchanged in a market for a uniform quality and value” that “fall well within the common definition of ‘commodity’ as well as the CEA’s definition of ‘commodities’” and that “[w]here a futures market exists for a good, service, right, or interest, it may be regulated by CFTC, as a commodity, without regard to whether the dispute involves futures contracts.” MBC goes further by stating that an active market for futures contracts for one type of virtual currency subjects the full “category” of virtual currency to regulation by the CFTC.

United States v. Zaslavskiy

In United States v. Zaslavskiy, the defendant argued that the virtual currencies at issue were “currencies,” not securities, and therefore not subject to the Exchange Act. Judge Dearie was unconvinced, noting that “simply labeling an investment opportunity as a ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract — a security — into a currency.” While stating that whether the sale of virtual currencies at issue would meet the Howey test (and therefore be considered investment contracts) is a “highly fact-specific inquiry” to be proven at trial, Judge Dearie believed the indictment sufficiently alleged facts that a reasonable jury could conclude that the virtual currency met the definition of an investment contract.⁷

1pool Ltd.

1pool Ltd. (1pool), a company registered in the Marshall Islands, operated an online trading platform that allowed users to transact “contracts for difference” (CFDs) with 1pool as the counterparty to each transaction. A CFD is generally an agreement to exchange the difference in value of an underlying asset between the time at which the trading position is established and the time at which it is terminated. The underlying assets of the CFDs available on 1pool consisted of commodities such as gold and crude oil, as well as securities and market indices — giving rise to both CFTC and SEC assertion of regulatory authority.

Users, including retail customers, were able to create accounts on the 1pool trading platform by providing an email address and user name. No other identifying information was required. Accounts could be funded only in bitcoin, and all transactions on the platform were settled in bitcoin. 1pool’s activities violated a variety of laws under the Securities and Exchange Acts and the CEA, including offering unregistered security-based swaps, trading security-based swaps on an unregistered exchange, acting as an unregistered dealer, acting as an unregistered futures commission merchant and failing to implement an adequate know-your-customer/customer identification program pursuant to Financial Crimes Enforcement Network (FinCEN) regulations under the Bank Secrecy Act.

Although 1pool’s illicit activities are not specific to virtual currency, the parallel complaints (assisted by an undercover special agent from the Federal Bureau of Investigation and the Department of Justice) illustrate the heightened scrutiny companies conducting virtual currency business activities may expect to receive.

Takeaways

The MBC and Zaslavskiy orders add to the growing judicial precedent interpreting how virtual currency is treated under the law and where the jurisdictional boundaries lie.1pool further shows that conduct related to virtual currency may fall within multiple regulators’ purview. As Judge Weinstein noted in McDonnell, many regulators have jurisdiction over virtual currencies. Depending on the relevant facts and circumstances, a virtual currency may be a security regulated by the SEC, a commodity regulated by the CFTC or something else.⁸ The context in which virtual currencies (or other digital assets) are used will determine the applicable legal framework regulators and courts will apply to that asset.

However, questions remain:

With respect to the CFTC’s jurisdiction over virtual currencies, how broad or narrow is the “category” of “virtual currency”? Are all digital assets included? What and how many characteristics must a digital asset share with a virtual currency in which contracts for future delivery are traded to be a commodity as defined by the CEA? Does the market for futures contracts need to be based in the U.S., or is anywhere in the world sufficient? If the Chicago Merchantile Exchange and Chicago Board Options Exchange cease trading in bitcoin futures, but such contracts are actively traded abroad, does the CFTC have anti-fraud enforcement power with respect to virtual currency? Such questions are critical given the court’s unambiguous recognition that the CFTC’s expanded authority under the Dodd-Frank Act is not limited to fraudulent market manipulation and extends to all types of fraud.

With respect to when a virtual currency may be considered a security, the Zaslavskiy case is consistent with the SEC’s approach in the DAO Report, which applied the Howey test to determine whether the sale of a virtual currency is an investment contract.⁹  However, Judge Dearie stated that “whether the conspirators in fact offered a security, currency, or another financial instrument altogether, is best left to the finder of fact — unless the Court is able to answer it as a matter of law after the close of evidence at trial.” Given the variety of ways in which virtual currencies have been marketed and sold, it may be unclear when a virtual currency is a security as a matter of law and when such a determination will require extensive fact-finding.

Although not subject to lengthy discussion in either complaint, the SEC and the CFTC’s charges against the Marshall Islands-registered 1pool and its Austrian CEO may raise jurisdictional questions. While the complaints allege that 1pool made use of the instrumentalities of interstate commerce and solicited U.S. customers, these allegations and whether 1pool sufficiently directed its activity toward the U.S. may be disputed. Where the purchase and sale of the CFDs is deemed to have taken place (and whether such transactions are subject to U.S. law under Morrison) will also need to be answered. ¹⁰

¹ For example, see our prior Sidley Update on SEC enforcement related to virtual currency: One-Two-Three Punch: SEC and FINRA Announce Actions Against Unregistered Broker, Digital Asset Manager and FINRA Registered Person.

² Commodity Futures Trading Comm’n v. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ (D. Mass. Sept. 26, 2018).

³ United States v. Zaslavskiy, No. 1:17-cr-00647-RJD-RER (E.D.N.Y. Sept. 11, 2018).

⁴ Securities and Exchange Comm’n v. 1pool Ltd., No. 1:18-cv-02244 (D.D.C. Sept. 27, 2018). 

⁵ Commodity Futures Trading Comm’n v. 1pool Ltd., No. 1:18-cv-02243 (D.D.C. Sept. 27, 2018).

⁶ Commodity Futures Trading Comm’n v. McDonnell, No. 1:18-cv-00361-JBW-RLM, slip op. (E.D.N.Y. March 6, 2018) (mem.).

⁷  Under the test laid out by the Supreme Court, in brief summary, a transaction is an investment contract if there is an investment of money in a common enterprise with the expectation of profit derived from the efforts of others. SEC v. W. J. Howey Co., 328 U.S. 293 (1946).

⁸ For example, FinCEN treats “convertible” virtual currency as currency for the purposes of its money transmitter regulations. See Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FIN-2013-G001 (March 18, 2013). New York has implemented distinct rules that apply to “virtual currency business activities” (commonly known as the BitLicense).

⁹ Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Rel. No. 81207 (July 25, 2017).

¹⁰ Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010).