Bridging the Week by Gary DeWaal

Bridging the Week by Gary DeWaal: September 10 - 14 and September 17, 2018 (ICOs; Registration; Audit Trail; Reporting; Blue Sheets; Supervision)

Alternative Trading Systems    Blue Sheets    Books and Records    Bridging the Week    Compliance Weeds    Cryptosecurities    FinTech    Fraud and Anti-Fraud    Legal Weeds    Managed Money    My View    Position and Trade Reporting    Supervision   
Published Date: September 16, 2018

A federal court in Brooklyn, New York, issued a much-anticipated decision, holding that digital assets issued as part of initial coin offerings could be securities under applicable law. Although this decision was issued solely in response to a defendant’s motion to dismiss an indictment, the outcome validates views frequently espoused publicly by the Securities and Exchange Commission's chairman and staff that such digital assets may be investment contracts, and thus securities. Separately, on Friday evening in a hurricane of activity, the Commodity Futures Trading Commission announced the filing and settlement of 12 separate actions naming multiple companies and persons based on allegations of acting without proper registration, as well as audit trail recordkeeping and swaps reporting violations. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Brooklyn Federal Court Rules ICO-Issued Digital Assets Could Be Securities (includes Legal Weeds and My View); 
  • In a Friday Night Hurricane, CFTC Batters 12 Firms and Multiple Individuals for Various Offenses, Including Non-Registration, Faulty Reporting and Recordkeeping Breakdowns (includes Compliance Weeds);
  • SEC and FINRA File Unrelated Enforcement Actions Charging Digital Assets-Related Securities Law Violations (includes Compliance Weeds):
  • Feeling Blue (Sheets): Broker-Dealer Resolves SEC Enforcement Action for Faulty Electronic Regulatory Submissions for US $2.75 Million Fine (includes Compliance Weeds); and more

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  • Brooklyn Federal Court Rules ICO-Issued Digital Assets Could Be Securities: A US federal court in Brooklyn, New York, declined to dismiss a criminal indictment against Maksim Zaslavskiy charging him with securities fraud and related offenses in connection with two cryptocurrency investment schemes and their related initial coin offerings.

Mr. Zaslavskiy had argued that the indictment should be dismissed because his activities did not involve securities and that the relevant law prohibiting fraud in connection with the offer and sale of securities was unconstitutionally vague. The court rejected Mr. Zaslavskiy’s arguments, saying that, at least for the basis of the defendant’s motion to dismiss, the government had sufficiently alleged that the relevant digital assets were securities and that the relevant law prohibiting fraud is not unconstitutionally vague as applied in his case.

The government initially charged that Mr. Zaslavskiy, through two companies he founded – REcoin Group Foundation, LLC and DRC Work, Inc. (known as Diamond Reserve Club) – offered investors an opportunity to obtain new cryptocurrencies – REcoin and Diamond – through an ICO and an “initial membership offering,” respectively. Purportedly REcoin was backed by real estate chosen by a team of experts, while Diamond was backed by diamonds. However, alleged the government, the defendant never developed the relevant cryptocurrencies, and investors purchasing REcoins, or exchanging REcoins for Diamond digital assets received no digital assets in return. Moreover, no cryptocurrencies created by Mr. Zaslavskiy were supported by any asset. (Click here to access a copy of the criminal complaint against Mr. Zaslavskiy.)

In ruling against the defendant, the court said that the government had alleged sufficient facts demonstrating that REcoin and Diamond were investment contracts under applicable legal precedent (i.e., (1) an investment of money, (2) in a common enterprise with (3) the expectation of profits solely from the efforts of a promoter or third party; click here to access the initial articulation of this standard in SEC v. WJ. Howey, a 1946 Supreme Court decision). However, the court noted that the fact-finder hearing Mr. Zaslavskiy’s trial would ultimately make the final decision regarding the nature of the purported cryptocurrencies based on facts presented at that time.

Prior to the criminal complaint being filed against Mr. Zaslavskiy, the Securities and Exchange Commission filed a civil complaint in the same federal court. (Click here for background in the article “SEC Files Lawsuit Against Companies and Backer for Purportedly Fake Initial Coin Offerings” in the October 1, 2017 edition of Bridging the Week.) This action was stayed pending resolution of the criminal case in January 2018.

Legal Weeds: This decision is a very important decision for both the Department of Justice and the Securities and Exchange Commission as it confirms the SEC’s position that crypto assets issued as part of ICOs could be securities if they satisfy the elements of an investment contract as set forth by the Supreme Court in Howey. This view was most prominently stated by the SEC in a Report of Investigation related to digital tokens offered and sold by DAO, an unincorporated virtual organization, during April and May 2016. (Click here for background in the article “SEC Declines to Prosecute Issuer of Digital Tokens That It Deems Securities Not Issued in Accordance with US Securities Laws” in the July 26, 2017 edition of Between Bridges.)

Just a few weeks ago, a different judge in the same federal district court in Brooklyn handed the Commodity Futures Trading Commission a similar affirmation of its own authority. There, in connection with an enforcement action by the CFTC against Cabbagetech Corp. and Patrick McDonnell, its owner and controller, the court entered an order of permanent injunction, imposed a civil penalty of approximately US $871,000, and ordered restitution of approximately US $290,000 against the defendants for unlawfully soliciting customers to send money and virtual currencies for virtual currency trading advice and for the discretionary trading of virtual currencies.

In ruling against the defendants, the federal court held that virtual currencies are commodities and that the CFTC had jurisdiction to bring its enforcement action relying on the fraud-based manipulation prohibition in the Dodd-Frank Wall Street Reform and Consumer Protection Act and a parallel CFTC rule. (Click here to access Commodity Exchange Act Section 6(c)(1), 7 U.S.C. § 9(1) and here for CFTC Rule 180.1)

(Click here for full details regarding the Cabbagetech decision in the article “Federal Court Enters Final Judgment Against Alleged Virtual Currency Fraudster; Confirms CFTC Authority to Bring Enforcement Action” in the August 26, 2018 edition of Bridging the Week.)

My View: Hopefully, the government’s initial victory in  Zaslavskiy will empower the SEC to thoughtfully engage with the industry to more precisely differentiate among cryptocurrencies that are not securities, digital assets that are likely securities and digital assets that principally serve a utility purpose, even if traded on secondary markets. William Hinman’s open reflection regarding ether and the characteristics of digital assets a few weeks ago was a good starting point but seems to have been somewhat undercut by Chairman Jay’s Clayton’s pronouncement last week that when staff speaks on topics, they only speak for themselves, not the SEC. (Click here for commentary elsewhere in this edition of Bridging the Week regarding this development. Mr. Hinman is the SEC's Director of the Division of Corporate Finance.)

The SEC and CFTC have long dealt with products that have characteristics of futures and securities – instruments known as security futures – and have worked out rules for the exercise of their jurisdiction over such products. (Click here for general background.) Using this precedent as a basis, the SEC and CFTC should be able to carve out formal criteria for when a cryptocurrency is not a security.

Similarly, relying on its own precedent, the SEC should be able to provide more definitive guidance when a digital asset meant to be used exclusively on an associated blockchain for services or functionality is not a security token solely because it may trade on a secondary market. As divisions of the SEC have seemingly acknowledged on multiple occasions, just because something has some qualities of an investment contract – like a baseball stadium's seat leases – and trade on secondary markets – like eBay – doesn’t mean they should be regulated as securities. (Click here, e.g., for a request for no action by the San Francisco Baseball Associates L.P. related to seat leases and here for the grant of no-action relief by the Office of Chief Counsel of the Division of Corporate Finance on February 24, 2006.)

Beanie babies and original issue 2008 Tesla Roadsters are not securities solely because they trade on secondary markets and rise or fall in value because of the promotional activities of Ty Inc. and Elon Musk. 

  • In a Friday Night Hurricane, CFTC Batters 12 Firms and Multiple Individuals for Various Offenses, Including Non-Registration, Faulty Reporting and Recordkeeping Breakdowns: In an unusual Friday evening blitz after 6 pm ET, the Commodity Futures Trading Commission announced the filing and settlement of 12 enforcement action against multiple firms and individuals for violations of applicable laws and CFTC rules.

Audit Trail Retention Breakdown

In one action, the CFTC said that ABN AMRO Clearing Chicago LLC did not retain, as required, electronic audit trail information for 65 clients. This problem was discovered when the CFTC found gaps and missing transaction records in the firm’s production in response to a request for documents related to one client. Afterward, ABN initiated an internal investigation and discovered its more widespread breakdowns. These were caused by the failure of an archiving system to copy data supplied to the firm by an external vendor from January 24, 2014, through August 28, 2015. The CFTC noted that, although ABN had a recordkeeping system in place, it had no system to monitor whether its archiving system was properly collecting or storing data. ABN agreed to pay a fine of US $160,000 to resolve the CFTC’s enforcement action. In accepting the firm’s settlement, the CFTC noted ABN’s cooperation and self-efforts to determine the scope of its problems.

Unregistered Commodity Trading Advisor

Mobius Risk Group LLC resolved an allegation by the CFTC that, from approximately October 2012 to August 15, 2018, it acted as a commodity trading advisor in providing risk management advice to its energy clients – which included views related to the advisability of trading in over-the-counter swaps and commodity options in oil, natural gas and liquefied natural gas – without registering as a CTA. Among other things, claimed the CFTC, during the prior one year, the firm provided trading advice to more than 15 persons, and the advice was not incidental to Mobius’s overall business. Services Mobius provided in the normal course – all for a flat fee – included market analysis and monitoring, risk strategy management, customized risk management services, market forecasting and trade execution as agent. Mobius’ clients apparently were all eligible contract participants and legally qualified under applicable law to enter into OTC swaps. The firm consented to pay a fine of US $75,000 to resolve the CFTC’s allegations.

Reporting Violations

Honouround (HK) International Trade Co. Ltd – a Hong Kong-based entity – agreed to pay a fine of US $300,000 to settle CFTC claims that it violated position limits in soybean futures traded on the Chicago Board of Trade between March and April 2017, and failed to file CFTC Form 204 reports regarding its fixed-price cash positions in soybeans and related positions during the same time it exceeded speculative position limits. During the relevant time, said the CFTC, the firm violated both the single-month and all-month 15,000 contracts limit then in effect. Although the CFTC said it twice emailed Honouround relevant Form 204s after its position limit breaches, the Commission claimed the firm did not file the Form 204s until July 2018, after it became aware that the Division of Enforcement would recommend an enforcement action against it.

Unrelatedly, NatWest Markets Plc (formerly The Royal Bank of Scotland plc) consented to a fine of US $750,000 for not timely and accurately reporting hundreds of thousands of swap transactions to a swap data repository as required under applicable requirements. Among the firm’s alleged failures was that it under- and over-reported transactions, misreported transactions, and failed to timely report swaps transactions executed prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act but that were in effect on or after April 25, 2011 (“pre-enactment swap transactions”). The CFTC said that RBS’s errors related to swaps creation data, swaps continuation data, unique swap indicators, pre-enactment swap transactions, and corrected swaps data; they occurred from January 2013 to the present. In accepting NatWest’s settlement, the CFTC noted the firm’s cooperation with staff and investigation into RBS’s deficiencies.

Forex and Binary Options

The CFTC also filed and settled eight separate enforcement actions against firms and individuals, claiming that the firms acted as a CTA or commodity pool operator, and the individuals as associated persons, without required registration, when they advised, engaged in discretionary trading, or managed funds on a collective basis for retail customers related to foreign exchange and binary options. The firms and individuals settled the CFTC’s charges by, among other things, agreeing to desist from the purportedly wrongful conduct and paying fines that, in aggregate, totaled US $950,000.

Compliance Weeds: Commercial firms providing risk management services regarding tangible commodities must be careful not to engage in activities that inadvertently cause them to run afoul of CFTC registration requirements, such as providing recommendations on futures or swaps trading for a fee as described in the CFTC’s action against Mobius, or processing customers’ orders for futures contracts, holding their positions, and accounting for profits and losses on their behalf.

In March 2017, Davisco Foods International, Inc., an international cheese and food ingredient company headquartered in Le Sueur, Minnesota, agreed to pay a fine of US $150,000 to the CFTC to resolve allegations that it acted as an FCM without being registered as required by law in connection with a hedging program it administered for its milk suppliers. The CFTC claimed that Davisco’s milk suppliers placed orders with the firm for CME milk futures contracts that Davisco then executed for its own trading account. Suppliers subsequently received “debits and credits” to their accounts at Davisco. (Click here for background in the article “Price Protection Is Price Protection Is Price Protection – Unless It’s FCM Activity Says CFTC” in the April 2, 2017 edition of Bridging the Week.)

Likewise, persons trading futures in any of the futures contracts for which the CFTC has established express position limits must be mindful of their potential obligation to file Form 204s with the CFTC if they are hedgers and exceed such levels, except for persons trading cotton that may have additional requirements under Form 304. (The relevant futures are those involving corn and mini-corn, oats, soybeans and mini-soybeans, wheat and mini-wheat, soybean oil, soybean meal, hard red spring wheat, cotton no. 2 and hard winter wheat; click here to access CFTC Rule 150.2.)

CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be prepared as of the close of business on the last Friday of each relevant month.

Part III of CFTC Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; this is currently 100 contracts) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be prepared as of the close of business on Friday every week, and received by the CFTC in New York by no later than the second business day following the date of the report.

Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Parts I and II Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report.

(Click here to access applicable CFTC rules related to Forms 204 and 304. Click here to access a 2013 CFTC Advisory on Form 304.)

The CFTC proposed changes to its Form 204s and 304s as part of its re-proposed regulations establishing position limits for 25 core physical commodity futures contracts and their economically equivalent futures, options and swaps. (Click here for details in the December 19, 2016 Advisory, “CFTC Finalizes Aggregation Rules and Re-Proposes Positions Limits Rules” by Katten Muchin Rosenman LLP.)

  • SEC and FINRA File Three Unrelated Enforcement Actions Charging Digital Assets-Related Securities Law Violations: The Securities and Exchange Commission and the Financial Industry Regulatory Authority brought unrelated enforcement actions against multiple defendants for disparate violations of securities laws for transactions involving digital assets. The SEC settled its two enforcement matters; the FINRA matter is pending. This is the first enforcement action charging violations of laws in connection with the offer and sale of digital assets brought by FINRA.

No Registration of Entities

In one action, the SEC claimed that Tokenlot, LLC and its two owners and operators, Lenny Kugel and Eli Lewitt, operated as broker-dealers when they solicited and sold digital assets connected with initial coin offerings that were securities, but were not registered as such with the SEC, in violation of law. The SEC claimed that the individuals promoted the company as an “ICO Superstore,” and assisted customers in private and pre-sales of ICO-issued security tokens as well as the secondary market trading of such digital assets. To resolve this matter, respondents agreed to disgorge almost $479,999, including interest, while Mr. Kugel and Mr. Lewitt also each agreed to pay fines of US $45,000, among other sanctions.

In the second action, the SEC charged that Crypto Asset Management, LP and Timothy Enneking, CAM’s founder and sole principal, unlawfully operated a fund – Crypto Asset Fund, LLC – that invested more than 40 percent of its value in digital assets that were securities without complying with applicable law. The SEC charged that the sale of interests in CAF without the interests being registered as a security or an exemption being available was unlawful, as was CAF operating as an investment company without being registered as such. The respondents were also charged with making false or misleading statements to investors. To resolve this action, respondents agreed to pay a fine of US $200,000 among other sanctions.

Unregistered Security

FINRA commenced a disciplinary proceeding against Timothy Ayre, for trying to attract investors to purchase shares in a worthless company he owned and served as president – Rocky Mountain Ayre, Inc. (“RMTN”) – by making material misstatements in public filings, and by unlawfully offering to the public digital assets – HempCoins – that he claimed were backed by RMTN common stock. FINRA charged that the sale of HempCoins was unlawful as they were unregistered securities that were not eligible for any exemption. FINRA also claimed that Mr. Ayre engaged in private securities transactions involving RMTN while employed by a broker-dealer without disclosing such transactions to his employer, in violation of the firm’s written supervisory procedures. 

In other developments regarding digital assets:

  • Stablecoins. The New York State Department of Financial Services approved Gemini Trust Company LLC and Paxos Trust Company LLC to each offer cryptocurrencies pegged to the US dollar. Each cryptocurrency must be supported by one US dollar held by the relevant NY limited purpose trust company, and each company must comply with various enumerated conditions in connection with their authorization; and
  • BitGo. BitGo announced that it has received a license as a South Dakota Trust Company by the South Dakota Division of Banking. The company claims that it is the first qualified custodian for storing digital assets.

Compliance Weeds: Under FINRA rules, no registered person may be directly or indirectly employed in any other capacity in a business activity outside the scope of his or her relationship with his or her member firm unless he or she has given prior written notice to the member. (Click here to access FINRA Rule 3270.) Additionally, a person associated with members must also provide advance written notice to his or her employer if he or she may engage in a securities transaction outside the regular course or scope of his or her employment, including new offerings of securities which are not registered with the SEC, subject to various exceptions and conditions. (Click here to access FINRA Rule 3280.)

Earlier this year, Arthur Meunier a/k/a Arthur Breitman agreed to be suspended for two years from association with any FINRA-regulated broker-dealer to settle FINRA charges that, from February 2014 to April 2016, he participated in the development of Tezos, a blockchain technology project, without notifying the broker-dealer he was then employed by of such activity, as required by FINRA rules. (Click here for background in the sub-article “FINRA Fines a Tezos Co-Founder” in the April 22, 2o18 edition of Bridging the Week.)

FINRA’s action against Mr. Ayre also includes an allegation that he engaged in private securities transactions without notifying the broker-dealer he worked for at the time.

FINRA’s inclusion of an additional charge against Mr. Ayre for his engagement in private security transactions involving RMTN while employed by a broker-dealer that required disclosure of such transactions by its written supervisory procedures is another implicit warning to firms that it is best to ensure they have WSPs that track applicable FINRA rules regarding outside business activities and private securities transactions, and that they remind their associated persons that these requirements apply to transactions involving security tokens as well as business activities involving all digital assets, in addition to traditional securities and business activities.

  • Feeling Blue (Sheets): Broker-Dealer Resolves SEC Enforcement Action for Faulty Electronic Regulatory Submissions for US $2.75 Million Fine: The Securities and Exchange Commission brought and settled an enforcement action against Convergex Execution Solutions, LLC (now known as Cowen Execution Services, LLC), a registered broker-dealer, for submitting to it data that was incomplete or deficient in response to a high number of electronic blue sheet requests. 

These deficiencies, which occurred from May 2012 through February 28, 2016, included customer identifying information such as customer names, addresses, or taxpayers' identification. The SEC said that other missing or deficient fields related to information about the securities transaction reported, such as order execution times, exchange codes, transaction type identifiers and certain execution information that was reported at an aggregate but not on a per trade basis.

The SEC noted that, after Convergex was sanctioned by the Financial Industry Regulatory Authority in March 2012 for problematic EBS submissions, it instituted a new software platform to validate such transactions. However, while the revised system identified some deficiencies, it did not detect many of the deficiencies in the EBS reports provided to the Commission. Among other things, Convergex had no process to compare information reported to the SEC in its EBS submissions with information in underlying databases, said the SEC.

Convergex agreed to pay a fine of US $2.75 million to settle the SEC’s enforcement action.

Blue sheets refer to trade data submitted by certain regulated entities, including broker-dealers, to the SEC and self-regulatory organizations such as FINRA in an automated form in response to requests by the regulatory bodies in connection with their investigations, typically of equity market activity.

Compliance Weeds: In July 2016, Citigroup Global Markets Inc. agreed to pay a US $7 million fine to the Securities and Exchange Commission to resolve charges that, from 1999 through 2014, it submitted 2,382 erroneous blue sheets with it and 753 erroneous blue sheets with the Financial Industry Regulatory Authority. According to the SEC, these errors occurred as a result of a coding error in Citigroup’s electronic blue sheet computer system that was not detected until 2014.

A few weeks earlier, Deutsche Bank Securities Inc. agreed to pay a fine of US $6 million to resolve charges brought by the Financial Industry Regulatory Authority that it filed “thousands” of deficient blue sheets with it and the Securities and Exchange Commission from 2008 through 2015.

Relevant entities that may be required to file electronic blue sheets with regulators should periodically review submissions against source information to ensure their systems are properly collecting and processing such data internally.

(Click here for additional background in the article “Computer Coding Error Results in Broker-Dealer Blue Sheets’ Errors Over 15 Years and US $7 Million SEC Fine” in the July 17, 2016 edition of Bridging the Week.)

More Briefly:

  • Broker-Dealer and Affiliate Agree to Pay More Than US $12 Million to Resolve SEC Charges for Allegedly Misleading Dark Pool Practices: Citigroup Global Markets, Inc. and Citi Order Routing and Execution, LLC agreed to disgorge profits and pay interest of US $5.437 million and pay a penalty of US $6.5 million to resolve charges in connection with their operation of a dark pool called “Citi Match.” Among other things, the SEC claimed that CGMI purportedly misled investors when it marketed Citi Match as a venue that did not allow access by high-frequency traders when, in fact, two trading firms accounting for more than 17 percent of all executions by dollar volume likely qualified as HFTs. The SEC also said that CGMI did not adequately disclose to all users that orders sent to Citi Match could be routed to and executed in various external venues that did not offer the same promoted advantages as Citi Match. Additionally, the SEC asserted that, because buy and sell orders could rest in Citi Match and automatically execute pursuant to preprogrammed priority rules and procedures, CORE met the definition of an exchange and should have been registered as a national securities exchange. Both CMGI and CORE were solely registered as broker-dealers with the SEC during the relevant time. In January 2016, two other broker-dealers paid aggregate sanctions of US $156 million to the SEC and the New York Attorney General to resolve charges that they too purportedly misrepresented how they shielded their dark pools' participants from HFTs. (Click here for background in the article, Two Broker-Dealers to Pay US $154 Million to the State of NY and the SEC to Resolve Allegations of Wrongdoing by Their Dark Pools" in the February 7, 2016 edition of Bridging the Week.)
  • Two CME Group Nonmember Firms Sanctioned for Failing to Supervise Employees Who Engaged in Exchange Rule Violations: Two nonmembers were fined by CME Group exchanges for failure to supervise employees and agents. In one disciplinary action, Enterprise Products Partners, LP, agreed to pay a fine of US $100,000 to the New York Mercantile Exchange, as a result of its employees entering into multiple wash trades between March and December 2016 in crude oil, heating oil, natural gas, and RBOB futures contracts. The NYMEX business conduct committee said the firm never provided its employees instruction or guidance related to the exchange-prohibition against wash trades. Moreover, the NYMEX BCC said that, during the relevant time, Enterprise failed to ensure its employees used unique user Tag 50 identification codes to access Globex. Separately, Zerich Securities Limited consented to remit a fine of US $75,000 collectively to both NYMEX and the Commodity Exchange, Inc., for the failure of one of its agents to trade in natural gas futures contracts without proper written authorization. According to the NYMEX and Comex BCCs, Zerich’s agents also backdated authorization forms and altered information on account opening documents.

Compliance Weeds: In October 2016, two CME Group exchanges brought and settled disciplinary actions against a trading company and two of its employees for engaging in alleged spoofing-type activities on NYMEX and Comex. To resolve the matter, the trading firm agreed to disgorge profits of US $91,241. For the actions of its two traders, the trading firm was charged by the CME Group exchanges with violating just and equitable principles of trades and related violations, but solely on a strict liability basis. The firm was not charged with failure to supervise, and it was not assessed a fine. The CME Group exchanges implied that no fine was assessed because the firm had and enforced robust policies and procedures regarding the purported wrongful conduct of its employees. (Click here for background in the article “CME Group Settles With Trading Firm for Spoofing-Type Offenses, Holding It Strictly Liable for Acts of Agents; Orders Disgorgement of Profits” in the October 9, 2016 edition of Bridging the Week.)

  • SEC Notes That Staff Views Are Just That – Staff Views and Not the SEC’s: Jay Clayton, chairman of the Securities and Exchange Commission, issued a statement noting staff statements solely reflect their personal opinions, and are non-binding and create no enforceable rights or obligations on the Commission. Only rules and regulations formally adopted by the Commission have the force of law, he said. 

My View: A few weeks ago, William Hinman, Director of the SEC’s Division of Corporate Finance, indicated in a speech that, in his view, ether – the digital payment asset associated with the Ethereum blockchain – did not have the qualities of a security. He equated ether with bitcoin for such purposes. He enumerated a number of characteristics that, to him, would likely render a digital asset a security, applying the Howey test (click here to access the Supreme Court decision in SEC v. WJ. Howey (1946)). The significance of Mr. Hinman’s statements appears undercut by Mr. Clayton’s latest pronouncement – although it is also only a speech and not an SEC rule or regulation. (Click here for background on Mr. Hinman’s speech in the article “Anything but Sleep Inducing: SEC Corporate Finance Director Says Ether Not a Security and Canada Issues Guidance on Utility Tokens” in the June 17, 2018 edition of Bridging the Week.)

  • FINRA Identifies Opportunities and Potential Issues With RegTech in White Paper: The Financial Industry Regulatory Authority issued a white page discussing regulatory technology developments in the securities industry, and possible benefits and implications of these developments. Among other things, FINRA noted that regtech developments have significantly impacted firms’ surveillance and monitoring activities and potentially will allow a greater volume and variety of information to be “readily” analyzed. Additionally, regtech startups and incumbents are introducing solutions to enhance customer identification for know-your-customer purposes. These developments could help members’ compliance and anti-money laundering activities. However, FINRA cautioned that the use of enhanced systems could have implications for firms’ supervisory control systems, outsourcing oversight, security, and customer data privacy. FINRA will accept comments on topics raised in its white paper through November 30.
  • NY DFS Sues OCC Over FinTech License; Other State Financial Regulators Say Their Legal Challenge is Right Behind: The New York State Department of Financial Services sued the Office of the Comptroller of the Currency in connection with its recent determination to potentially issue special purpose federal charters for financial technology firms. DFS claimed that OCC's determination was "lawless, ill-conceived and destabilizing of financial markets that are properly and most effectively regulated by New York State." The legal action was filed in a federal court in Manhattan. Separately state bank regulators also indicated they will renew litigation previously filed but dismissed as premature against the OCC over the same fintech charter. NY DFS and state regulators previously sued the OCC, alleging it had no authority to grant such charters that, it claimed, would be harmful to markets and consumers. The relevant federal courts hearing the lawsuits dismissed both actions as premature. (Click here for background regarding the states' banking regulators' prior action in the article “Federal Court Rejects States’ Challenge to Potential OCC Fintech Charter” in the May 6, 2018 edition of Bridging the Week; click here for details regarding NY DFS's prior action in the sub-article “Challenges to NY BitLicense and Potential OCC Fintech Charter Quashed” in the January 7, 2018 edition of Bridging the Week.)


  • Four Defendants Sentenced for Role in Hedge Fund Insider Trading Scheme Based on Nonpublic Information Related to Medicare Reimbursement Rates: The four persons criminally charged in 2017 for participating in a scheme to obtain confidential proprietary information related to Medicare reimbursement rates from a federal agency and to trade on it for profit from at least 2012 through 2014 were sentenced from one year and one day to three years in prison, following their convictions in May 2018. The scheme involved David Blaszczak, a health insurance consultant; Christopher Worrall, a senior staff manager in the Centers for Medicare and Medicaid Services, part of the US Department of Health and Human Services; and Theodore Huber and Robert Olan, partners and analysts at Deerfield Capital Management. (Click here for background on the initial criminal and SEC complaints against the individuals in the article “Alleged Conduit to Hedge Fund for Confidential Nonpublic Government Information Criminally Charged for Insider Trading Along With Three Fund Partners and Government Employee” in the June 4, 2017 edition of Bridging the Week.)

For further information

Broker-Dealer and Affiliate Agree to Pay More Than US $12 Million to Resolve SEC Charges for Allegedly Misleading Dark Pool Practices:

Brooklyn Federal Court Rules ICO-Issued Digital Assets Could Be Securities:

Feeling Blue (Sheets): Broker-Dealer Resolves SEC Enforcement Action for Faulty Electronic Regulatory Submissions for US $2.75 Million Fine:

FINRA Identifies Opportunities and Potential Issues With RegTech in White Paper:

Four Defendants Sentenced for Role in Hedge Fund Insider Trading Scheme Based on Nonpublic Information Related to Medicare Reimbursement Rates:

In a Friday Night Hurricane, CFTC Batters 12 Firms and Multiple Individuals for Various Offenses, Including Non-Registration, Faulty Reporting and Recordkeeping Breakdowns:

NY DFS Sues OCC Over FinTech License; Other State Financial Regulators Say Their Legal Challenge is Right Behind:

SEC and FINRA File Three Unrelated Enforcement Actions Charging Digital Assets-Related Securities Law Violations:

SEC Notes That Staff Views Are Just That – Staff Views and Not the SEC’s:

Two CME Group Nonmember Firms Sanctioned for Failing to Supervise Employees Who Engaged in Exchange Rule Violations:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 15, 2018. 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. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or other employees.





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