U.S. Government Steps Up Its Enforcement in the Digital Assets Space | JD Supra

Our Blockchain & Digital Assets Team offers a snapshot sample of significant recent developments by a panoply of federal agencies and departments that represent the expanding array of enforcement tools used by federal regulators in the digital assets space in recent months.

  • Multiple agencies are joining forces and coordinating efforts to bring actions against crypto companies
  • Several agencies have created new divisions specifically for crypto-asset investigations and prosecutions
  • Expect more “regulation by enforcement” until Congress and the states can pass legislation codifying agencies’ powers

Cryptocurrency is no longer on the fringe of the financial services industry. With over $1 trillion in market cap, star-studded Super Bowl ads, and an endless supply of frontpage headlines, there is no denying that crypto has entered the mainstream. The same is increasingly true for other digital assets and blockchain-based technologies, such as non-fungible tokens (NFTs). While the federal government largely took a “wait and see” approach to these emerging financial technologies over the last decade, the pace of enforcement activity by multiple agencies touching these spaces has been ramping up and filling the void caused by the absence of a comprehensive regulatory framework.

Following President Biden’s Executive Order on Ensuring Responsible Development of Digital Assets issued in March (covered in a prior Alston & Bird advisory), there has been a flurry of enforcement activity touching all types of players in the industry, with serious implications for crypto exchanges, investors, promoters, service providers, and the companies that do business with them. There have been significant recent developments by a multitude of federal agencies and departments, including the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), Department of Justice (DOJ), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Consumer Financial Protection Bureau (CFPB), Office of Foreign Assets Control (OFAC), and Department of Labor (DOL). These agencies have used a variety of supervisory and enforcement tools to establish boundaries, send messages to the industry, and signal an appetite for future action, which we expect to continue at a rapid pace.

Securities and Derivatives (SEC/CFTC)

SEC expands crypto enforcement unit

On May 3, 2022, the SEC announced that it had nearly doubled the size of the specialized enforcement unit tasked with investigating and litigating alleged misconduct in the crypto markets. The newly renamed Crypto Assets and Cyber Unit now has 50 dedicated positions, including 20 new positions consisting of investigative staff attorneys, trial counsel, fraud analysts, and supervisors across the United States. The expanded unit will focus on investigating securities law violations related to: (1) crypto offerings; (2) crypto exchanges; (3) crypto lending and staking products; (4) decentralized finance (DeFi) platforms; (5) NFTs; and (6) stablecoins.

With a much deeper bench, a clear mandate to hunt down violations across a wide swath of the crypto-assets space, and a solid enforcement track record to support future actions, we expect even more vigorous enforcement by the SEC. The SEC’s core crypto playbook was built on “regulation by enforcement,” evidenced by more than 80 crypto-related enforcement actions since 2017, over $2 billion secured from defendants, and many novel fact patterns, including charges alleging that Poloniex operated an unregistered digital asset exchange, that Blockchain Credit Partners used smart contracts and DeFi technology to sell unregistered digital tokens, and that promoters of BitConnect’s “lending program” failed to register as broker-dealers.

But the agency has also been broadcasting potential theories of liability in guidance issued over the last several years, and it may be emboldened because it deems crypto participants to be on more-than-ample notice. Examples include the 21(a) Report of Investigation on The DAO issued in 2017, the Framework for “Investment Contract” Analysis of Digital Assets issued in 2019, and Staff Accounting Bulletin No. 121 related to crypto disclosures issued in March. SEC leadership has repeatedly offered warnings as well, such as SEC Chair Gary Gensler’s recent speech reiterating that “most crypto tokens are investment contracts under the Supreme Court’s Howey Test” and therefore securities subject to SEC regulation.

More creative theories of liability may also be on their way. First, the SEC’s expanded crypto unit helps fulfill the anti-crime/anti-fraud provisions of President Biden’s Executive Order and is a way for the agency to keep pace with the “whole of government” approach and potentially assert its jurisdiction in gray areas. Second, the SEC recently proposed amendments to Regulation ATS that would sweep in “Communication Protocol Systems that make available for trading any type of security,” potentially requiring crypto platforms and DeFi protocols to register as broker-dealers or exchanges. If finalized, these amendments would provide the SEC with access to far more information about the crypto markets and provide enforcement hooks for future actions. The SEC has now reopened the comment period for these amendments, and comments must be received on or before June 13, 2022.

SEC names crypto as an exam priority

On March 30, 2022, the SEC also named crypto-assets as an exam priority and “significant focus area” for 2022. The Division of Examinations emphasized that market participants involved in crypto-assets will be scrutinized on (1) their “offer, sale, recommendation, advice, and trading” of crypto-assets, “with a focus on duty of care and the initial and ongoing understanding of the products”; and (2) whether they “routinely review, update, and enhance their compliance practices …, risk disclosures, and operational resiliency practices” related to crypto custody arrangements, including “crypto-asset wallet reviews, custody practices, anti-money laundering reviews, and valuation procedures.”

Broker-dealers, investment advisers, and other market participants should expect exam staff to shine a bright light on any involvement they have with crypto, which could lead to enforcement referrals if regulatory violations are uncovered. Market participants should not only pay close attention to the risk areas highlighted in the 2022 examination priorities but also consider revisiting the SEC’s 2021 guidance on digital asset exams to understand other risk areas the SEC is scrutinizing.

We also expect the SEC to home in on market participants’ interactions with retail investors in particular. For example, in the release announcing the expanded crypto unit, Enforcement Director Gurbir Grewal stated, “Crypto markets have exploded in recent years, with retail investors bearing the brunt of abuses in this space.” In congressional testimony on May 17, 2022, Gensler also stated that “the highly volatile and speculative crypto marketplace has mushroomed, attracting tens of millions of American investors and traders,” and “[t]he volatility in the crypto markets in recent weeks highlights the risks to the investing public.”

CFTC and SEC coordinate their efforts

The CFTC has been active in crypto-related enforcement as well. On May 18, 2022, CFTC Chairman Rostin Behnam reportedly told an industry conference that the CFTC has filed more than 50 crypto-related actions since 2015 and is looking to prioritize this area with an influx of additional resources. As just one example of a recent high-profile action, on May 5, 2022 the CFTC announced that it had secured a $30 million civil money penalty against the co-founders of the Bitcoin Mercantile Exchange (BitMEX) crypto and crypto derivatives trading platform for alleged registration and anti-money laundering (AML) violations. This action notably occurred alongside a parallel criminal action, and the CFTC acknowledged the assistance provided by the U.S. Attorney’s Office for the Southern District of New York and FinCEN.

Relatedly, Gensler revealed in a recent speech that he has asked SEC staff to “consider how best to register and regulate platforms where the trading of securities and non-securities is intertwined,” and particularly “to work with the [CFTC] on how we jointly might address … platforms that might trade both crypto-based security tokens and some commodity tokens, using our respective authorities.” The two agencies are reportedly developing memorandums of understanding related to their jurisdiction in the crypto space.

These developments show that government agencies are not hesitating to coordinate, even where their jurisdiction over the crypto markets is overlapping or unclear.

Criminal Enforcement (DOJ)

Through enforcement, policy, and resourcing, the DOJ continues to signal an unwavering focus on crypto-related matters and a continued expansion of the scope of crypto-related matters under investigation. Indeed, in remarks delivered at the February 2022 Munich Security Conference, Deputy Attorney General Lisa Monaco stated that the DOJ is “issuing a clear warning to criminals who use cryptocurrency to fuel their schemes. We also call on all companies dealing with cryptocurrency: we need you to root out cryptocurrency abuses. To those who do not, we will hold you accountable where we can.”

The DOJ’s recent enforcement actions demonstrate the wide range of areas where crypto-assets feature in DOJ investigations and prosecutions, and they serve as a reminder not only of the many threats companies with…

Read More: U.S. Government Steps Up Its Enforcement in the Digital Assets Space | JD Supra

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