Bridging the Week by Gary DeWaal: April 8 – 12 and April 15, 2019 (Not In An Empire State Of Mind; Mistrial For Programmer)

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Published Date: April 14, 2019

The New York State Department of Financial Services cancelled the temporary authority of a major cryptocurrency exchange to operate in New York, saying its failure to meet anti-money laundering, AML compliance officer quality and potential capital requirements disqualified it for a BitLicense or a money transmitter license. The firm now has less than 60 days to liquidate or off-load its existing NY customers. Separately, a mistrial was declared in the criminal action against the alleged programmer for the purported flash crash spoofer in connection with two counts of aiding and abetting spoofing. The prosecution has less than two weeks to determine whether to subject the programmer to a second criminal trial. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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NYSDFS denied Bittrex’s license and revoked its authority to conduct a virtual currency business in New York, saying the firm could not “demonstrate it will conduct its business honestly, fairly, equitably, carefully and efficiently” as required by applicable law and rules.

In response, Bittrex issued a written statement saying it was “saddened and disappointed” by NYSDFS’s action. 

Under NY law and rules, persons engaging in a virtual currency business involving New York or NY persons must typically have a NY BitLicense and a money transmitter license. The BitLicense requirement was adopted in 2015. In 2018, New York amended its rules for persons engaged in a virtual currency business to require a program for monitoring for fraud, including manipulation. (Click here for background on NY BitLicense requirements in the article “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” in a July 8, 2015 Advisory by Katten Muchin Rosenman LLP. Click here for additional information on the 2018 augmentation of requirements for persons conducting a NY virtual currency business in the article “NYS Financial Services Regulator Ups the Obligations of State-Licensed Virtual Currency Entities” in the February 11, 2018 edition of Bridging the Week.)

According to NYSDFS, Bittrex’s current anti-money laundering and economic sanctions compliance program are inadequate; it was not certain that Bittrex followed its own guidelines in approving digital tokens for trading on its own platform; and Bittrex would not commit to comply with NYSDFS’s capital requirements. In connection with the firm’s AML program, NYSDFS indicated that Bittrex lacked adequate policies and procedures; may not have employed an AML compliance officer with adequate experience who evidenced an appropriate level of authority and effectiveness; did not adequately train employees; and may not have had adequate independent testing of its AML program, all of which are required under applicable rules. 

Bittrex vehemently disputed NYSDFS’s findings, but acknowledged that it was on a “journey to improving and maturing our compliance function.” The firm noted that “[c]orporate responsibility is in our DNA and our commitment to regulatory and compliance guidelines is second to none.” In response to NYSDFS's claim that Bittrex was unwilling to commit to meet the Department's financial requirements the firm claimed that "NYDFS imposed capitalization requirements in excess of that of any other state despite Bittrex's industry leading security and cold storage procedures."

Under NYSDFS’s order, in addition to suspending its NY business by last week, Bittrex is required to wind down or transfer existing positions of NY residents by June 9, 2019.

Separately, NYSDFS granted a BitLicense to Bitstamp USA Inc., a subsidiary of Bitstamp Ltd. Under its license, Bitstamp is authorized to enable its customers to buy and sell bitcoin and other designated cryptocurrencies, as well as facilitate transfer of funds onto the Ripple network, issuing Ripple balances in US dollars and select non-US fiat currencies, as well as other virtual currencies. According to a statement by Bitstamp, the firm “has always embraced regulatory efforts which focus on transparency and accountability that help expand the industry.” Bitstamp’s approval marked the 19th approval by NYSDFS of a company to engage in a virtual currency business in New York.

In other legal and regulatory developments involving cryptoassets:

Memory Lane and My View: In September 2018, the New York Attorney General issued a report claiming that trading platforms for cryptocurrencies often (1) engaged in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. Moreover, the report named three cryptocurrency platforms that it alleged might have been operating unlawfully in New York at the time, and said it referred these platforms to the NYSDFS for possible further action. However, no public enforcement or other action by the NYSDFS has been announced against any identified firm since the NY AG report.

The NY AG’s report followed a voluntary request for information sent to 13 cryptocurrency platforms earlier last year. 

Just as the NY AG report appeared at the time to be a damning public indictment of multiple cryptoasset exchanges without the ordinary protection afforded defendants in judicial processes, NYSDFS denial of Bittrex’s license transformed what should be private interactions into public theater. It may well be that NYSDFS was justified in its bottom-line determination, but the public way it excoriated Bittrex seems inappropriate.

That being said, a fundamental flaw of founders and promoters of both permissioned and permissionless blockchain networks is they all presume their system design is the best. Although such persons may, for permissionless systems, espouse the benefit of peer-to-peer non-intermediated transactions through “disruptive” decentralized, cryptographically secure networks, such a benefit only exists for transactions on a specific blockchain. They do not exist for transactions across blockchains, such as exchanges of one digital asset for another or for interactions involving the real world, such as exchanges of fiat currency for a digital asset. These cross-blockchain network transactions today require third-party intermediation as different digital networks are generally not natively interoperable. 

As a consequence, it is not unexpected that regulators seek to impose minimum qualifications on such intermediaries to protect customers, and it is equally not unexpected that many of such intermediaries in the relatively new cryptoasset industry have little or no experience dealing with experienced financial regulators. As Bittrex acknowledged about its own situation, “[We are] a young innovative company that believes in the future of blockchain technology. Bittrex will continue to mature its compliance program because we believe in being good corporate citizens, and because we believe in the rule of law. We will continue to work with the many other regulators, and we will continue to take constructive feedback to improve our ability to be the corporate citizens we have set out and committed to be.” 

Hopefully, as the cryptoasset industry continues to evolve, regulators and legitimate industry participants will continue to work together to ensure an appropriate environment for customers without resorting to inflammatory front page headlines and public shaming absent fraud or other purposely nefarious conduct.

(Click here for additional information regarding the AG’s findings in the article “NY Attorney General Says Investors Risk Abusive Trading and More on Crypto Platforms” in the September 23, 2018 edition of Bridging the Week.)

My View: The outcome of a hung jury in this case was surprising, but the failure of 10 jurors to vote for Mr. Thakkar’s conviction for aiding and abetting Mr. Sarao’s spoofing is significant. Clearly, for the 10 jurors, the DOJ did not provide sufficient proof beyond a reasonable doubt that Mr. Thakkar programmed software with knowledge that Mr. Sarao intended to use such software for illicit spoofing purposes. Previously, the government had endeavored to have the jury convict Mr. Thakkar on a lesser standard  – i.e., if they found he had a strong suspicion that the relevant software would be used for spoofing, but he purposely avoided confirming that fact. However, the judge rejected this “Ostrich Instruction.” 

Given the apparent weakness of the DOJ’s evidence and the challenge of flipping 10 jurors, it seems an inappropriate use of the public purse to retry Mr. Thakkar. 

More Briefly:

For further information

CME Group Consolidates Guidances Regarding Prohibited Activities During Pre-Opening Sessions:

Coordinator of National Financial Regulators Publishes Directory of International Crypto Regulators:

Developer of Decentralized Computing Network Files Reg A+ Offering for SEC Approval:

For Departing Registered Reps, Tell Customers How Accounts Will Be Handled Says FINRA in Reg Notice:

Multinational Bank Resolves Purported Breaches of US Sanctions Program and AML Breakdowns by Paying Over US $1.1 Billion to Multiple Government Overseers:

Mistrial Declared in Prosecution of Purported Programmer for Alleged Flash Crash Spoofer:

New York State Department of Financial Services Revokes Crypto Exchange’s Safe Harbor to Operate Without BitLicense:

Representatives Propose New Legislation to Carve Out Utility Tokens From Application of Securities Laws:

SEC Commissioner Criticizes Regulation by No Action:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 13, 2019. 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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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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