Last week, the Financial Industry Regulatory Authority disclosed its examination priorities for this year. FINRA’s focus will include, among a wide swath of traditional concerns, evaluating how member firms and their salespersons may be facilitating transactions in cryptocurrencies and initial coin offerings. Separately, a private lawsuit was filed against a virtual currency exchange for not returning customers’ funds. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- FINRA Announces 2018 Examination Priorities; Will Review Role of Firms and Salespersons in Facilitating Cryptocurrency Transactions and ICOs (includes Compliance Weeds);
- Class Action Lawsuit Filed Against Crypto-Exchange for Allegedly Not Returning Clients’ Funds (includes My View); and more.
- FINRA Announces 2018 Examination Priorities; Will Review Role of Firms and Salespersons in Facilitating Cryptocurrency Transactions and ICOs: The Financial Industry Regulatory Authority issued its 2018 Regulatory and Examinations Priorities Letter last week setting forth the areas of focus for its inspections of member firms this year. FINRA’s attention will principally be on fraud, high-risk firms and natural person brokers, operational and financial risks, sales practice risks and market integrity.
Among other things, FINRA will be evaluating whether firms’ controls are sufficient to meet their suitability obligations. The regulator “will pay particular attention to suitability determinations where registered representatives recommend complex products to unsophisticated, vulnerable investors.”
Specific sales practice risks FINRA will be reviewing include how firms and their salespersons may facilitate transactions in cryptocurrencies and initial coin offerings. Where an ICO involves the sale of a security, FINRA may look to review the “supervisory and operational infrastructure” a firm has implemented to comply with applicable securities laws and regulations as well as FINRA rules.
FINRA will also be examining firms’ written business continuity plans – particularly after Hurricanes Harvey and Maria – to assess how firms will have continued access to critical systems even when they may not have physical access to relevant offices. Among other things, FINRA will consider how firms implement their BCPs, evaluating under what circumstances a BCP will be activated; how a system may be assessed as critical; how data back-ups and recovery are effectuated; and, as applicable, how firms coordinate with their affiliates and vendors during a situation requiring activation of their BCPs.The self-regulatory organization will also review firms’ technology governance and cybersecurity program effectiveness and anti-money laundering program adequacy. In examining firms’ AML programs, FINRA will assess the adequacy of written policies and procedures to identify and report suspicious transactions; resources committed to AML; and independent testing. FINRA expressed concerned about firms that do not monitor, or monitor less robustly, accounts of affiliates.
FINRA will also focus on firms’ detection of possible manipulation; compliance with best execution requirements, the Securities and Exchange Commission’s Market Access Rule and Regulation SHO; and adherence to fixed income data integrity and reporting requirements. Additionally, FINRA will look for possible front running of correlated option products, as well as the adequacy of surveillance of alternative trading systems.
FINRA encouraged members to consider its proposed 2018 priorities in conjunction with its 2017 Examination Findings Report published last December (click here to access). In its Findings Report FINRA made specific recommendations on how firms might improve their cybersecurity and AML programs, enhance their fulfillment of their suitability obligations, and comply with Reg MAR and Reg SHO, based on its observations of effective practices at member firms.
Compliance Weeds: The beginning of the year provides a natural opportunity for registrants to review their written policies and procedures to ensure they still reflect actual practices. It is easy, over time, for policies and procedures to go stale. Unfortunately, if something goes wrong, it will not be helpful to have actual practices that are inconsistent with written policies, or written policies that are so generic they provide no real basis for actual practices.
Additionally, FINRA’s 2018 Regulatory and Examination Priorities Letter read in conjunction with its 2017 Examinations Findings Report provides an excellent resource for broker-dealers to assess the adequacy of their policies, procedures and practices against objective standards. FINRA’s publications provide a useful tool against which other SEC and Commodity Futures Trading Commission registrants may evaluate comparable policies and procedures (e.g., AML, cybersecurity).
- Class Action Lawsuit Filed Against Crypto-Exchange for Allegedly Not Returning Clients’ Funds: Vircurex – a virtual currency exchange – and one of its purported principals were named in a lawsuit filed in a US federal court in Colorado alleging breach of contract, conversion, constructive fraud and unjust enrichment.
According to Timothy Shaw, the named plaintiff in the purported class action lawsuit, Vircurex was founded in October 2011. Although the exchange claims to be incorporated in Belize, this may not be true, claims the plaintiff. The exchange appears to still be operating. (Click here for access to Vircurex’s website.)
The lawsuit alleges that, following its disclosure in March 2014 of two hacking incidents in mid-2013, Vircurex “was nearing insolvency,” and had insufficient Bitcoin and other alt-coins to meet its obligations to customers. The lawsuit claims that, in response, Vircurex froze customer accounts, although it promised to repay its clients over time. To date, claims the plaintiff, this repayment has not been completed.
Also named in the lawsuit were Andreas Eckert, one of the alleged organizers of Vircurex, and “John Doe,” a non-identified purported organizer located in China. Among other things, plaintiff seeks a return of his funds and costs.
Last month, various media sources reported that Youbit, a South Korea-based cryptocurrency exchange, filed for bankruptcy (click here for a sample article).
Among other developments last week involving cryptocurrencies:
- Secretary of the Treasury Says FSOC Studying Cryptocurrencies: In an interview before the Economic Club of Washington DC on January 12, Steven Mnuchin, Secretary of the US Department of Treasury, said that the Federal Stability Oversight Counsel established a working group to study cryptocurrencies at its last meeting. Mr. Mnuchin said, “We are very focused on … cryptocurrencies.” His two principal priorities regarding cryptocurrencies are to ensure “that bad people cannot use these currencies to do bad things,” and that, “consumers who are trading [cryptocurrencies] understand the risks” in order to avoid being hurt. He said he was not concerned at all that foreign nations such as Russia might develop their own cryptocurrencies to evade sanctions. Created under the Dodd-Frank Wall Street Reform and Consumer Protection Act, FSOC consists of representatives of nine federal agencies (including the Commodity Futures Trading Commission and the Securities and Exchange Commission) and one independent member, and is authorized to identify and monitor excessive risks to the US financial system. (Click here to access Mr. Mnuchin’s interview.)
- Bitcoin ETF Applications to the SEC Withdrawn: Two firms seeking to list exchange-traded Bitcoin funds – Direxion Shares ETF and ProShares ETF Trust – withdrew their applications with the Securities and Exchange Commission. Both entities – which had filed their applications following the self-certification to the Commodity Futures Trading Commission by three exchanges to list Bitcoin derivatives contracts on December 1, 2017 – indicated their withdrawals were at SEC staff’s request. ProShares sought approval for funds that apparently would have traded Bitcoin futures and not spot Bitcoin. According to Direxion in a letter withdrawing its application (click here to access), “[s]taff expressed concerns regarding the liquidity and valuation of the underlying instruments in which the Fund intends to primarily invest and requested that the Trust withdraw the Amendment until such time as these concerns are resolved.” (Click here for background on the self-certification by three derivatives exchanges in the article “Three CFTC-Regulated Exchanges Self-Certify Bitcoin Derivatives Contracts” in the December 3 edition of Bridging the Week. Click here to access a copy of the ProShares withdrawal letter.)
- Second State Enjoins BitConnect: North Carolina became the second state to issue a summary cease and desist order against BitConnect, a UK-based cryptocurrency-issuing company, in connection with various digital currency-related investment programs (click here to access the order). The Securities Division of the NC Department of the Secretary of State claimed that BitConnect is selling unregistered securities while not being registered as a dealer or salesman of securities in the state and omitting material facts when offering investments. The Texas State Securities Board previously brought a similar action against BitConnect. (Click here for details in the article “CFTC Issues Explanation of Its Oversight and Approach to Virtual Currency Markets; Texas Securities Board Enjoins Initial Coin Offering” in the January 7, 2018 edition of Bridging the Weeks.)
- Foreign Countries’ Developments: The Malaysia Securities Commission issued a cease and desist order against the CopyCash Foundation – the backers of a proposed initial coin offering involving CopyCashCoin. The Securities Commission claimed that disclosures in CopyCash’s whitepaper issued in conjunction with its ICO and other presentations to potential investors likely violated applicable securities laws. (Click here to access a copy of the order.) Separately, the Korean Financial Intelligence Unit and the Korean Financial Supervisory Service announced they had begun examining six commercial banks’ compliance with anti-money laundering requirements in connection with their offer of trading accounts on Korean cryptocurrency exchanges. Among other things, the regulators seek to assess whether the banks have electronic systems to ensure that the name of a deposit account holder matches that of a virtual account holder.
My View: The Commodity Futures Trading Commission and the Securities and Exchange Commission appear to be taking increasingly divergent approaches to cryptocurrencies. Whereas the CFTC has been aggressive in promulgating consumer education and bringing enforcement actions against violators of relevant laws, it has also granted registration to a swap execution facility and clearing organization that trades and settles Bitcoin derivatives, and has not precluded the self-certification of cash-settled Bitcoin derivatives products. On the other hand, the SEC appears reluctant – even with the advent of Bitcoin derivatives trading on CFTC-overseen markets – to authorize Bitcoin ETFs. The SEC and CFTC should work together to promote clarity in their oversight, not impede the development of digital ledger technologies and related cryptocurrencies, and continue to enforce relevant laws against miscreants – much as the CFTC already is doing. As CFTC Chairman J. Christopher Giancarlo has written, “[o]ne thing is certain: ignoring virtual currency trading will not make it go away. Nor is it a responsible regulatory strategy.”
- Senate Agricultural Committee Leaders Encourage CFTC to Retaliate Against EC Should EC Withdraw From 2016 Joint Clearinghouse Agreement: Leaders of the Senate Committee on Agriculture, Nutrition and Forestry encouraged the Commodity Futures Trading Commission to retaliate against the European Commission should it determine, as a result of Brexit, not to abide by the terms of a 2016 agreement to recognize each other’s overseen clearinghouses as being subject to equivalent regulatory oversight. (Click here for background regarding this agreement in the article “CFTC Approves Substituted Compliance Framework for EU-Based DCOs; EC Formally Recognizes US CCPs as Subject to Equivalent Regulation” in the March 20, 2016 edition of Bridging the Week.) According to Chairman Pat Roberts and ranking Democratic member Debbie Stabenow, “[i]f the EC moves away from the 2016 CFTC-EC agreement, the CFTC should review the appropriateness of the exemptions and relief it has granted to foreign entities, including clearinghouses established in the European Union.” In June 2017, the EC proposed that, after Brexit, it might impose direct requirements on certain non-EU-based clearinghouses that provide services in the European Union. (Click here for background in the article “EC Proposes Two-Tier System for Classifying Third-Country CCPs; Certain Systemically Important CCPs May Be Required to Relocate to the EU” in the June 18, 2017 edition of Bridging the Week.)
- FERC Rejects Plan to Subsidize Coal and Nuclear Power Plants: The Federal Energy Regulatory Commission rejected a proposal by Secretary of Energy Rick Perry to subsidize the coal industry by requiring coal and nuclear power plants to maintain at least 90 days of fuel supply on-site in order to ensure the resilience of US electric power grids. Instead, FERC ordered that a new study be conducted to examine any risks to resiliency US electric grid operators may face and possible ways to address any identified risks. FERC expects all regional transmission organizations and independent system operators to respond to FERC queries within 60 days.
- FCM Fails to Persuade Court to Dismiss Liquidator’s Claims That Payments Made by Sentinel Management Prior to Bankruptcy Were Fraudulent Transfers: MBF Clearing Corporation failed to have dismissed an amended complaint filed against it by Sentinel Liquidation Trust that claimed MBF’s receipt of certain funds from Sentinel Management prior to SM’s collapse in 2007 constituted a prohibited fraudulent conveyance. A US federal court in Illinois previously dismissed the Liquidation Trust’s efforts to claim back funds paid by SM to MBF on the grounds the transfers were an avoidable preference, but did so without precluding the filing of an amended complaint. The US federal court in Illinois evaluating the Liquidation Trust’s current lawsuit rejected MBF’s claims that the amended filing was barred by the statute of limitations (because the amended action related back to the original lawsuit) or by the doctrine of latches (because it was court inaction not the Liquidation’s Trust actions that delayed a re-filing). (Click here for background on this matter in the article “Sentinel Management Former CEO Sentenced to 14 Years in Prison for Fraud; Former Head Trader Receives Eight-Year Term” in the February 1, 2015 edition of Bridging the Week.)
- Hong Kong-Based Blockchain Company’s Trading Suspended by SEC: The Securities and Exchange Commission temporarily suspended trading in securities of Hong Kong-based UBI Blockchain Internet, Ltd. The SEC took its emergency unilateral action because of concerns related to the accuracy of information in the firm’s filings since at least September 2017 regarding its business operation, and “recent, unusual, and unexplained” market activity in some of the company’s shares since November 2017. The temporary suspension will expire at 11:59 pm EST on January 22.
- NFA Reminds Members About Doing Business With Exempt CTAs and CPOs: The National Futures Association issued its annual reminder that members dealing with lawfully exempt-from-registration commodity trading advisors and commodity pool operators should take “reasonable steps” through the first quarter of 2018 to ensure such persons are lawfully exempt. This is because lawfully exempt CTAs and CPOs have until March 1 to file with the NFA an annual affirmation regarding their exemption and, if they do not, may be required to be registered. Reasonable steps, said NFA, include reviewing certain information regarding such CPOs and CTAs it provides online. NFA members are not permitted to conduct a customer business with persons required to be registered with the Commodity Futures Trading Commission and members of the NFA who are not.
- ICE Futures Europe to Transition Certain Energy Contracts to ICE Futures Europe in February: ICE Futures Europe and ICE Futures U.S. announced that, as of trade date February 19, 2018, various North American Oil and Financial Natural Gas Liquids contracts would cease to trade on IFEU and commence trading on IFUS. The transitioned contracts will continue to be cleared at ICE Clear Europe.
- OFAC Designates New Persons and Entities for Violating Human Rights and Supporting Sanctioned Weapons Creators: The Office of Foreign Assets Control of the US Department of Treasury added 14 persons to its sanction lists. These persons and entities, all from Iran, were added, said OFAC, because of their connection with human rights abuses and censorship, as well as support of sanctioned Iranian weapons developers.
For further information:
Class Action Lawsuit Filed Against Crypto-Exchange for Allegedly Not Returning Clients’ Funds:
FCM Fails to Persuade Court to Dismiss Liquidator’s Claims That Payments Made by Sentinel Management Prior to Bankruptcy Were Fraudulent Transfers:
FERC Rejects Plan to Subsidize Coal and Nuclear Power Plants:
FINRA Announces 2018 Examination Priorities; Will Review Role of Firms and Salespersons in Facilitating Cryptocurrency Transactions and ICOs:
Hong Kong-Based Blockchain Company’s Trading Suspended by SEC:
ICE Futures Europe to Transition Certain Energy Contracts to ICE Futures Europe in February:
NFA Reminds Members About Doing Business With Exempt CTAs and CPOs:
OFAC Designates New Persons and Entities for Violating Human Rights and Supporting Sanctioned Weapons Creators:
Senate Agricultural Committee Leaders Encourage CFTC to Retaliate Against EC Should EC Withdraw From 2016 Joint Clearinghouse Agreement:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 13, 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.
© 2018 Katten Muchin Rosenman. All Rights Reserved.