May Updates On Crypto Enforcement and Regulatory Guidance

In May, we noticed a slower month for crypto enforcement actions by state and federal regulators. See our March 2022 Crypto Enforcement Actions Roundup weblog here the place we focus on the regulatory steering and jurisdiction of federal and state businesses to implement these issues.

Federal and State Updates

Securities and Enforcement Commission (SEC)

On May 3, the SEC announced “the allocation of 20 additional positions to the unit responsible for protecting investors in crypto markets and from cyber-related threats.” Accordingly, the Crypto Assets and Cyber Unit within the Division of Enforcement might be expanded to “50 dedicated positions.”The Crypto Assets and Cyber Unit has introduced enforcement actions concerning securities legislation violations and for failure to take care of “adequate cybersecurity controls”—together with negligent practices in disclosing cyber-related dangers and incidents. The enlargement demonstrates the SEC’s intent to ramp up enforcement efforts, which we’ll watch intently.

Department of Treasury

On May 10, Treasury Secretary Janet Yellen introduced the Financial Stability Oversight Council (FSOC) Annual Report earlier than the Senate Banking Committee in regards to the want for wise stablecoin laws (we’ve got beforehand mentioned the President’s Working Group (PWG) report on stablecoins right here and here).  Secretary Yellen cites the findings within the PWG report as cause to conclude that “the current statutory and regulatory frameworks don’t provide consistent and comprehensive standards for the risks of stablecoins as a new type of payment products and urges Congress to enact legislation to ensure that stablecoins and such arrangements have a federal prudential framework.”

Commodity Futures Trading Commission (CFTC)

On May 19, the CFTC charged a number of people for fraudulently soliciting no less than $44 million for participation pursuits in a so-called “income fund” investing in digital belongings and different devices. The enforcement motion additionally fees the defendants with working an unlawful commodity pool and failing to register as a Commodity Pool Operator. The grievance alleges that since no less than January 2021, the defendants solicited greater than $44 million from no less than 170 members to buy, maintain and commerce digital belongings, commodities, derivatives, swaps, and commodity futures contracts. The grievance additionally alleges that as a substitute of investing the pooled participant funds as marketed, the defendants misappropriated participant funds by distributing them to different members, transferring some participant funds to different accounts underneath their management and for his or her profit, and transferring funds to a international cryptocurrency change. None of those funds have been returned to the pool.

On May 19, Rostin Behnam, Chairman of the CFTC publicly remarked that the CFTC will add assets and improve its efforts to handle cryptocurrency-related fraud and manipulation instances. He acknowledged, “[h]eadlines about the loss of tens of millions of dollars in digital assets due to protocol exploits, phishing attacks, preying on vulnerable people and other fraudulent and manipulative schemes have become far too common.” This assertion is a transparent sign of what actions the CFTC will possible pursue.

Financial Crimes Enforcement Network (FinCEN)

On May 19, Alessio Evangelista, the Associate Director of the Enforcement and Compliance Division of FinCEN, presented on the Chainalaysis Links Conference on the subject of “Intersection of Cryptocurrencies and National Security.”  Evangelista acknowledged that crypto companies “have the same obligations as all other financial institutions to ensure that their new offerings can leverage innovations while still protecting consumers, reducing cybercrime, combating illicit financial activity, and ensuring their platforms are not used to harm our national security.” He additionally pressured that the company believes that innovation goes hand in hand with regulation, relatively than being at odds with one another.

Evangelista additionally acknowledged that digital asset service suppliers (VASPs) ignore crimson flags and proceed to do enterprise with problematic corporations far too typically.  He known as on these VASPs to be proactive with regulatory compliance and to keep away from having “paper programs” or compliance regimes that exist on paper however usually are not applied, both by mistake or design. Here, FinCEN will proceed to prioritize instances the place it identifies “significant non-compliance and threats” to the monetary system and the place it finds “willful disregard for regulatory requirements.”

Office of the Comptroller of the Currency

On May 24, the performing Comptroller of the Currency, Michael Hsu remarked on the DC Blockchain Summit 2022 on the “deep” vulnerabilities of cryptocurrency in gentle of the current market volatility and different occasions within the crypto financial system.  Hsu emphasised the vulnerabilities arising from new blockchains spinning up operations.  Particularly, the crypto ecosystem has change into more and more fragmented, which presents interoperability points. Cross-chain bridges, though offering an answer to those points, are extremely susceptible to being hacked.

Hsu additionally emphasised that the interconnectedness of the crypto ecosystem presents actual contagion dangers, as evidenced by the current collapse of a preferred algorithmic stablecoin, which brought about different stablecoins to drop in worth. Moreover, Hsu cited the dearth of clear requirements for the possession and custody of digital belongings as inserting shoppers in danger.  Hsu believes these requirements are underdeveloped given the scale, scope, and ambitions of the trade. For instance, the biggest U.S. centralized change lately disclosed that its customers can be vulnerable to changing into unsecured collectors if the change have been to file for chapter.

Hsu additionally noticed that regardless of the volatility and lack of market capitalization after the current stablecoin collapse, there was no stress on conventional banking and finance resulting from crypto publicity, a consequence which he attributes, no less than partially, to federal financial institution compliance and intentional emphasis on security, soundness, and client safety.  Hsu discovered this to be a results of the OCC’s “careful and cautious” strategy to banks in search of to hitch the crypto financial system, referenced in Interpretive Letter 1179 issued final yr (we beforehand mentioned this letter in a weblog put up right here).

California State

Under a current Executive Order signed by Governor Gavin Newsom on May 4th, California is urging all state businesses to work with the federal authorities in creating laws for digital belongings. The govt order explains the significance of this motion in recognition of the truth that “California is the global innovation hub for emerging technologies because of the State’s unparalleled concentration of research and development, human and venture capital, and creativity and entrepreneurialism.”

Under the manager order, the state has seven priorities: (1) to create a clear and constant enterprise atmosphere for corporations working in blockchain; (2) to work concurrently and cooperatively with President Biden’s technique and efforts to establish accountable regulation; (3) to gather suggestions from a broad vary of stakeholders for potential blockchain functions and ventures; (4) to have interaction in a public course of and train statutory authority to develop a complete regulatory strategy to crypto; (5) to have interaction in and encourage regulatory readability by way of progress on the processes outlined within the federal govt order; (6) to discover alternatives to deploy blockchain applied sciences to handle public-serving and rising wants; and (7), to establish alternatives to create a analysis and workforce atmosphere to energy innovation in blockchain expertise.

Enforcement Actions

The Justice Department

On May 13, the Justice Department initiated its first legal prosecution involving the alleged use of cryptocurrency to evade financial sanctions. Magistrate Judge Zia M. Faruqui defined in a 9-page resolution that “cryptocurrency’s reputation for providing anonymity to users” is a “myth,” asserting that digital currencies equivalent to bitcoin, Ethereum or Tether are topic to the U.S. sanctions legal guidelines though they’re outdoors of the normal monetary system. Judge Faruqui defined that “OFAC’s current guidance confirmed that ‘sanctions compliance obligations apply equally to transactions involving virtual currencies and those involving traditional fiat currencies.” The complaint continued, “the Department of Justice can and will criminally prosecute individuals and entities for failure to comply with OFAC’s laws, together with as to digital foreign money.”

Conclusion

The crypto-regulatory and enforcement panorama stays a convoluted patchwork.  There are many authorized concerns involving NFTs, crypto, and different Web3 applied sciences.  What just isn’t murky, nevertheless, is the clear stance by U.S. regulators that, however the novelty of the expertise and asset class, fundamental rules nonetheless apply:  registered or not, builders, protocols, initiatives and platforms can’t defraud retail traders; they will’t support and abet cash laundering; and they will’t violate sanctions.