Bridging the Week by Gary DeWaal: September 11 to 15 and September 18, 2017 (ICOs; Digital Tokens; Spoofing; Advertising Standards)

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Published Date: September 17, 2017

Another non-US financial services regulator cautioned its citizens that some digital tokens issued as part of an initial coin offering may be securities subject to local securities law requirements, while the Securities and Exchange Commission in the US convinced at least one promoter of an ICO to cancel an in-progress offering and refund amounts already paid by investors in ether (the digital coin of the Ethereum blockchain network). Separately, another criminal proceeding was filed against a trader for spoofing, based on his trading activities involving precious metals futures listed on the Commodity Exchange, Inc. from July 2008 through November 2013. However, the specific criminal charge for spoofing seems to embrace alleged conduct that occurred before the relevant provision of law was effective in July 2011. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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(Click here for background on the SEC’s Report of Investigation in the article “SEC Declines to Prosecute Issuer of Digital Tokens That Violated US Securities Laws” in the July 30, 2017 edition of Bridging the Week.)

In response to the SEC’s inquiry, Protostarr voluntarily ended its ICO. According to a press release issued by the organization, “Unfortunately, as a startup, we do not have the necessary resources to both develop our [application] and challenge the SEC’s investigation regarding our ICO and its interpretation under US securities law.”

In addition to terminating its ICO, Protostarr indicated it would refund all ether—the digital currency of the Ethereum network—paid by individuals to its initial crowdsale payment address in a process that began on September 2.

Similarly, BTC China, one of the world's largest Bitcoin exchanges by volume and based in Shanghai, announced that it would end trading as of September 30 in response to the recent edict by seven regulators in China aimed at halting new ICOs. (Click here for background in the article, "China Bans ICOs While HK SFC Joins Regulator Procession Warning Digital Tokens in ICOs May Be Securities" in the September 10, 2017 edition of Bridging the Week.)

Separately, last week the UK Financial Conduct Authority joined a host of other international regulators in issuing guidance on ICOs that warned that some ICOs may involve regulated investments and firms conducting regulated activities, and that persons involved with an ICO should therefore consider their potential regulatory obligations.

My View: Last week, the leader of a major financial services firm labeled Bitcoin a fraud (click here for a sample public article describing this). With all respect, this characterization is wrong.

As background, Bitcoin—a type of digital token commonly referred to as a "cryptocurrency"—is first and foremost the reward to system administratorsmore commonly known as “miners”—for validating and maintaining the decentralized, open, distributed and inviolable ledger—known as the blockchain—that electronically records transactions involving Bitcoin between parties. This reward is a powerful incentive that encourages miners to invest in the necessary computer hardware and to pay the attendant costs of running computer systems that perform the critical function of maintaining the blockchain and ensuring its integrity. Bitcoin has perceived value much like gold and artistic works; similar to other valuable assets, there will only be a finite number of Bitcoin (approximately 21 million). In the secondary market, Bitcoin is a medium of exchange that that can be used like a fiat currency for purchases and has a relationship value with other cryptocurrencies and fiat currencies (into which Bitcoin can be converted). As a result of the secondary market and the perceived value of Bitcoin, miners can sell to others the Bitcoin they received as rewards for maintaining the blockchain to generate liquid funds to pay for the necessary hardware and attendant costs and potentially make a profit.

Bitcoin and the blockchain is a technology that allows disparate persons located almost anywhere on Earth to securely conduct financial transactions with each other without any intermediating agents very quickly and without material transaction fees. Notwithstanding the potential threat to such enterprises, many credible investment banks, banking organizations and other large companies are substantial investors in blockchain application initiatives because of the way the technology can potentially quicken transaction processing, eliminate certain current intermediation steps, and generate non-alterable records Such firms are determined to learn how to leverage this new technology for themselves and their clients and not be sidelined by it.

In fairness, Bitcoin—just like the US dollar—has been used for money laundering and for other illegal purposes. By design, transactions in Bitcoin are ordinarily conducted on a totally anonymous basis. However, the identities of participants can be known. This is why the Financial Crimes Enforcement Network of the US Department of Treasury and state regulators have been endeavoring more and more to tighten controls around certain intermediators of Bitcoin and other cryptocurrencies to ensure that robust anti-money laundering protocols are applied. However, Excel spreadsheets—far less sophisticated private ledgers compared to the blockchain distributed ledger—are not fraudulent solely because some crooks use them now and again to account for their profits, and no one is asking that the US dollar be banned because it is used widely for illicit purposes.

Additionally, Bitcoin is just one of many digital tokens and not all digital tokens have the same pedigree or purpose. Ethereum and its associated cryptocurrency, ether, for example, offer a more advanced form of the blockchain, and are particularly conducive for the development and use of so-called smart contracts—agreements between parties that will automatically self-execute pursuant to their terms without ongoing manual intervention. Other digital tokens are more like securities (cryptosecurities) and evidence a payment in kind for the funding of projects with an expectation of appreciated value after the development of a project by other persons. Some other digital tokens are more like private contracts (utility tokens) in that they are rewards for paying to play in a game or for participating in the development of a project—not as an investor but as an active consultant or in a similar capacity. Frankly, to me, there is often a blur among these categories and there is likely a profound quality difference among different types of digital tokens (not to mention their promoters).

Accordingly, going forward—as with any nascent industry—there will be bumps in the road. For sure, for example, the prices of Bitcoin and other cryptocurrencies are likely to go down as well as up and may, at times, evidence great volatility. However, over time, as the understanding of digital currencies and other digital tokens heightens, thoughtful regulation (and likely some government enforcement actions and private litigation too) will address many peripheral concerns, and the acceptance of digital tokens (along with their associated technology) will become more widespread.

Thus, there are many ways to describe Bitcoin. A fraud is not one. The blockchain is real and Bitcoin is integrally linked to this increasingly important new technology. We are at the beginning of a new technological revolution—not remotely near its end!

(Click here for a thoughtful analysis of cryptocurrencies and the possible use of their underlying technology by central banks published by the Bank of International Settlements on September 17.)

Publisher's Note: In a version of this My View prior to 10 am on September 18 I inadvertently referenced the "intrinsic" value of Bitcoin; This has been changed to the "perceived" value of Bitcoin. I don't believe that Bitcoin has intrinsic value anymore than gold has real intrinsic value (however, there are some very limited commercial uses for gold); both commodities have perceived value based on what economists reference as the "network effect."

Mr. Flotron apparently worked for UBS in Stamford, CT from January 2006 through October 2010, and in Zurich, Switzerland from October 2010 through January 2014; he currently resides in Zurich, but was arrested last week in connection with the complaint in New Jersey.

According to the complaint, on multiple occasions during the relevant time, Mr. Flotron along with others placed small-lot orders in gold, silver, platinum or palladium futures contracts on one side of the market close to the prevailing price, and around the same time, placed larger orders on the other side of the market, also close to the prevailing price. The objective of the large order, said the complaint, was to “trick other market participants by injecting materially misleading information into the market that indicated increased supply or demand, but was not genuine…” As soon as at least one lot of his small order was executed, Mr. Flotron would cancel the large order within no more than five seconds, alleged the complaint.

According to the complaint, many of the allegations against Mr. Flotron were based on the testimony of a non-identified subordinate trader—“Trader 1”—who joined Mr. Flotron’s trading operations in Stamford in July 2008, and was trained by Mr. Flotron.

The complaint charged Mr. Flotron specifically with conspiracy, wire fraud, commodities fraud and spoofing, although the provision of law addressing spoofing adopted as part of the Dodd‑Frank Wall Street Reform and Consumer Protection Act was not effective until July 16, 2011—three years after the beginning of Mr. Flotron's purported illegal conduct.

Legal Weeds: Last month, Michael Coscia’s criminal conviction and sentencing for spoofing was unanimously upheld by a three-justice Federal Court of Appeals panel in Chicago. Mr. Coscia was the first person criminally charged under the anti‑spoofing provision of Dodd-Frank. (Click here for background of this matter and another criminal spoofing case in the article “Federal Appeals Court Upholds Conviction and Sentencing of First Person Criminally Charged for Spoofing Under Dodd-Frank Prohibition” in the August 7 edition of Between Bridges.) Some of my Katten colleagues believe that, "[u]nderstood in context, the holding of Coscia is narrow, and preserves courts’ ability to limit prosecutors’ and regulators’ authority to label trading they do not like as 'spoofing'..." (Click here for the details of their analysis in the article, "United States v. Coscia: First Spoofing Conviction Leaves Hard Questions for Another Day" in the September 4, 2017 edition of Securities Regulation & Law Report.)

Compliance Weeds: For Commodity Futures Trading Commission registrants, National Futures Association Rule 2-29 provides detailed guidance regarding what constitutes acceptable communications with the public in connection with their trading or potential trading of futures and related options (click here to access NFA Rule 2-29). In general, communications cannot be deceptive or misleading, and may not use high-pressure sales tactics or be part of a high-pressure approach. In addition, NFA has published a separate brochure, “A Guide to NFA Compliance Rules 2-29 and 2-36,” to provide additional guidance (click here to access this brochure).

More briefly:

For further information:

CFTC Chairman Urges EU Regulators to Not Unilaterally Change CFTC-EU Equivalence Agreement on Supervision of Cross-Border Clearinghouses:


FINRA Panel Fines Broker-Dealer US $750,000 for Failing to Tailor AML Program to Actual Business:

Introducing Broker and Principal Settle NFA Charges That IB Benefitted from Third-Party Misleading Promotional Material

SEC OCIE Advises on Common Advertising Compliance Issues Identified During Investment Adviser Reviews:

SEC Begins Proactively Suggesting Some Promoters Halt ICOs; the UK Financial Conduct Authority Joins Worldwide Regulators Saying that Digital Tokens Issued as Part of ICOs May Be Securities:


Spoofing Case Filed in Connecticut Against Overseas-Based Precious Metals Trader:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 16, 2017. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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