Bridging the Week by Gary DeWaal

Bridging the Week by Gary DeWaal: January 7 – 11 and January 14, 2019 (Freedom of Speech; Cryptoasset Regulation Gaps; Cybersecurity)

Bitcoin Ecosystem    Bridging the Week    Compliance Weeds    Cryptosecurities    Cybersecurity    EMEA Regulation (sans Capital and Liquidity and UK after March 1, 2019)    Exchanges and Clearing Houses    Fraud and Anti-Fraud    My View    Policy and Politics    Trade Practices (including Disruptive Trading)   
Published Date: January 13, 2019

A well-renowned think tank sued the Securities and Exchange Commission claiming that the SEC’s prohibition against respondents contesting allegations in enforcement settlements violates the freedom of speech guarantee under the First Amendment to the US Constitution. The same prohibition also exists at the Commodity Futures Trading Commission. Separately, two European regulators warned that EU rules do not capture all cryptoasset activity, and there are gaps that should be addressed to enhance consumer protection. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Bag the Gag Orders Required by Respondents Settling SEC Enforcement Actions Requests Libertarian Think Tank in Federal Court Lawsuit (includes My View);
  • EU Banking and Markets Regulators Say European Financial Regulations Unevenly Applied to Cryptos or Not at All (includes My View); 
  • Follow-up: NFA Sets April 1 as Compliance Date for New ISSP Requirements (includes Compliance Weeds); and more.

In honor of the Martin Luther King, Jr. holiday on January 21, 2019, the next edition of Bridging the Week will be distributed on January 22, 2019.

Video Version:

Article Version


  • Bag the Gag Orders Required by Respondents Settling SEC Enforcement Actions Requests Libertarian Think Tank in Federal Court Lawsuit: In a lawsuit filed in a federal court in the District of Columbia, the Cato Institute – a well-renowned libertarian think tank – claimed that the Securities and Exchange Commission’s long-standing policy of requiring respondents never to contest any allegation in an enforcement action as a condition for a settlement is unconstitutional as it restricts freedom of speech. Cato alleged that, for the last 40 years, the SEC has routinely imposed an obligation of non-deniability in connection with all enforcement action settlements (“gag order”) pursuant to one of its regulations. (Click here to access 17 CFR 202.5(e).) 

According to Cato, it has been unable to publish a book detailing alleged overreaching by the SEC written by a former subject of an SEC enforcement action who was accused by the Commission of “substantial wrongdoing” but settled his/her matter. In the manuscript, the author said he/she admitted to engaging in “certain limited conduct in order [solely] to avoid crippling litigation expense.”

Cato entered into a contract to publish the author’s manuscript. However, in its complaint, the non-profit organization claimed that it cannot “exercise its contractual right to publish the book” because the author is bound by a gag order.

Cato seeks a permanent injunction against the SEC from requiring gag orders in administrative and civil settlements. In its complaint, it argues that content-based regulations of speech are “presumptively invalid” under the First Amendment to the US Constitution.

Cato describes itself as a “public policy research organization …dedicated to the principles of individual liberty, limited government, free markets, and peace.” (Click here for additional information on Cato.)

My View: According to Cato, when a respondent resolves an enforcement action with the SEC, he/she must “agree[] not to take any action or to make or cause to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis.” The objective of this provision is to preclude a respondent from publicly challenging the legitimacy of a settlement and thus undercutting the rationale for the SEC’s enforcement action. Without this constraint, a respondent could publicly attack the basis of SEC allegations, effectively requiring the SEC to defend its conduct to ensure its legitimacy.

However, the purpose of a settlement is to avoid litigation expense by both the SEC and a respondent. Allowing after-settlement back and forth public attacks would solely transfer arguments from a court room to a more uncontrolled environment, and raise challenges for the SEC to use non-public information obtained during investigations to help support its allegations in non-judicial forums. (Click here to access 17 CFR 203.2 regarding how the SEC customarily treats as non-public information or documents obtained during investigations.)

That being said, as Cato points out, the overwhelming majority of SEC enforcement actions conclude in settlements because the cost of litigation is prohibitive, and respondents often shelve their principles in response to cost-benefit analyses. As a result, respondents often proffer settlements where they formally neither admit nor deny any allegations (as mandated by the regulator), when in fact they may dispute many if not most of the allegations.

There likely is some middle ground that allows a respondent to deny any or all of the SEC allegations, but, notwithstanding, acknowledge such factual claims solely for the purpose of a settlement. Some limited ability for a respondent to explain the basis for its denial may be warranted and the SEC could likely respond summarily.

Cato’s lawsuit raises important issues regarding how to balance First Amendment protections and government agencies’ legitimate need for finality in voluntarily settled enforcement proceedings even where settlements are achieved through what are effectively coercive processes.

(The policy of the SEC regarding settlements also exists at the Commodity Futures Trading Commission. (Click here to access Appendix A to Part 10 of the CFTC Rules.) In 2014, current SEC commissioner Hester Peirce criticized the CFTC for “back-door rule-making” through the imposition of undertakings in enforcement settlement orders, among other reasons. At the time, Ms. Peirce was a Senior Research Fellow at the Mercatus Center at George Mason University. (Click here for access to Ms. Peirce’s article “Regulating Through the Back Door at the Commodity Futures Trading Commission”; specific reference at pgs. 60 -62.))

  • EU Banking and Markets Regulators Say European Financial Regulations Unevenly Applied to Cryptos or Not at All: Both the European Banking Authority and the European Securities and Markets Authority issued reports to the European Commission saying there were deficiencies in the applicability of existing regulations to cryptoassets and recommending further analysis.

Generally, the EBA found that cryptoassets typically fall outside the scope of EU banking, payments and electronic money regulations and that specific services relating to the provision of cryptoasset wallets and cryptoasset trading facilities are not touched at all by financial services law. As a result, there may be risks for consumers that are not addressed at the EU level, as well as the potential for money laundering.

Somewhat contrariwise, ESMA found that the applicability of EU regulations depended on the legal status of a cryptoasset. According to ESMA, for example, the majority of EU member states view at least some cryptoassets, e.g., those with imbedded profit rights, as potentially qualifying as transferrable securities or other types of regulated financial instruments. However, because some member states define transferrable securities restrictively and others apply broader interpretations, there are “challenges” to the oversight of cryptoassets. Under EU requirements, if a cryptoasset is a financial instrument, there are likely a broad range of applicable regulatory requirements, including prospectus, issuer transparency, trading and recordkeeping obligations.

ESMA claimed that even for cryptoassets that constitute financial instruments there likely is the need for “potential interpretation or reconsideration of specific requirements to allow for an effective application of existing regulations.” For cryptoassets that do not qualify as financial instruments (e.g., cryptocurrencies), “the absence of applicable financial rules leaves investors exposed to substantial risks.” At a minimum, said ESMA, anti-money laundering requirements and risk disclosure obligations should apply to all activities involving cryptoassets.

ESMA recommended that all gaps in regulation be addressed at the EU level.

Both EBA and ESMA noted that, at this time, cryptoasset activity in the European Union is limited and does not pose any danger to financial stability. ESMA additionally noted that “there could be benefits” in initial coin offerings if “appropriate safeguards are in place.”

In another legal development involving cryptoassets:

  • Colorado Proposed Law Would Exempt Consumptive Tokens from State Securities Laws: Legislators in Colorado have proposed a law that would exempt digital tokens from the application of the state’s securities laws provided such cryptoassets primarily have a consumptive purpose and are not marketed for speculative or investment purposes. As proposed, the consumptive purpose must be available at the time of the digital token’s issuance or within 180 days after sale for the cryptoasset to be exempt from the state’s securities laws. Subject to some requirements, persons effecting purchase and sales of consumptive tokens would be exempt from broker-dealer registration. Just prior to the expiration of the 115th Congress in 2018, Congressmen Darren Soto and Warren Davidson proposed legislation that would expressly define a digital token and make clear that securities laws would not ordinarily apply to digital assets issued on behalf of a project using a blockchain application once it becomes functional. (Click here for further details in the article “Congressmen Propose Law to Exclude Certain Cryptoassets from the Definition of a Security” in the January 6, 2016 edition of Bridging the Week.)

My View: As I have written previously, distributed ledger technology and associated cryptoassets continue to provide challenges to international regulators as the new technologies often do not fit neatly within existing laws. Although uniform best practices are appropriate for market participants to adopt voluntarily, there is a great danger that uniform or near uniform international regulations could stifle innovation.

For example, a recently adopted requirement by the Securities and Futures Commission in Hong Kong that restricts the participation in HK funds investing in cryptoassets to HK professional investors, as well as a potential prohibition against UK retail persons being able to purchase derivatives based on cryptocurrencies, is directly contrary to approval in the United States by the Commodity Futures Trading Commission of derivatives based on bitcoin accessible to all market participants, and guidance by the National Futures Association that permits funds accessible to all to invest in cryptoassets provided appropriate disclosures are made.

Uniformity in regulations sounds like a good thing, provided the regulations are right; however, what is right is in the eye of the beholder and may vary from person to person. As a result, efforts to promote common worldwide regulation of DLT and associated cryptoassets is likely inappropriate at the current time, when the relevant technologies are in their infancy and often misunderstood. (Click here for background on the HK requirement and UK proposal in the article “UK Regulators Contemplate Banning All Cryptocurrency-Based Derivative Sales to Retail Clients While HK SFC Restricts Investments in Virtual Currency Portfolios to Professional Investors” in the November 4, 2018 edition of Bridging the Week.)

It would be better at this point for regulators to agree, at most, on common broad objectives (e.g., eradicate fraud, heighten anti-money laundering requirements), but encourage individual jurisdictions to adopt regulations they believe most suitable in light of their own particular experiences. This way, controversial regulations might, at worse, inhibit innovations locally but will not have a deleterious international impact.

More Briefly:

  • Norway Regulator Censures Exchange in Connection with Recent Default: The Financial Supervisory Authority of Norway (Finanstilsynet) criticized the Norwegian branch of Nasdaq Clearing in connection with its handling and oversight of Einar Aas, the Norwegian power trader whose Nordic and German futures and forwards power spread positions went awry last year, prompting the exchange to place him in default on September 11, 2018, after he could not satisfy margin calls. The close-out of positions by the exchange exceeded Mr. Aas’s collateral and other members’ default fund contributions and required an extraordinary levy on members by Nasdaq Clearing to restore the default fund to Eur $107 million. 166 clearing member firms were required to make contributions on a pro rata basis. (Click here for general background regarding the default events, and here for a comprehensive set of related questions and answers by Nasdaq Clearing.) 

In its report, FSA criticized Nasdaq Oslo’s local adaption of policies and procedures “to ensure that internal controls can be carried out and documented in a proper manner.” The regulator also cited Nasdaq Oslo and its Norwegian branch for having a “blurred division of responsibilities and unclear reporting lines.” FSA urged Nasdaq Oslo to ensure that exchange members are fit at all times. The company must advise FSA of “corrective measures” it is instituting in response to FSA’s report by March 1. Separately, the Financial Supervisory Authority of Sweden (Finansinspektionen) issued a paper regarding auction proceedings used after a default and central counterparty clearing houses’ recovery and resolution capabilities, sparked by the September 2018 incident.

  • Non-Member’s Placement of Matching Buys and Sells Constituted Wash Sales Says CBOT: The Chicago Board of Trade’s business conduct committee fined Benn Hepworth, a non-member, US $50,000 for alleged wash trades. CBOT found that between October 17 and October 27, 2016, Mr. Hepworth implemented a wash trading scheme by placing buy and sell orders for the same product and expiration months that he reasonably knew would result in avoiding a bona fide market position exposed to market risk in the implied EU Wheat spread markets. Mr. Hepworth did not appear before CBOT to answer the charges against him. He was also subject to a three-year suspension from all CME Group exchanges by the exchange’s BCC. Separately, the North American Derivatives Exchange revoked the membership of Markeith Victoria for coordinating with other Nadex participants’ orders to trade against each other non-competitively  The exchange also found that Mr. Victoria operated an investment fund for customers without appropriate registration with the Commodity Futures Trading Commission, and apparently traded personally using at least one of his customer’s funds. Mr. Victoria was also fined US $2,500 by Nadex and banned from trading on the exchange’s markets directly or indirectly.


  • NFA Sets April 1 as Compliance Date for New ISSP Requirements: The National Futures Association’s recently proposed amendments to its 2016 interpretive notice on Information Systems Security Programs will be effective April 1, 2019. Under its 2016 notice, members must adopt and maintain an ISSP that addresses the risk of unauthorized access or attack on their information technology systems and how they will respond if attacked. The new amendments modify requirements related to training, ISSP approval, and notice to the NFA of cybersecurity incidents. (Click here for background regarding the NFA’s ISSP Interpretive Notice amendments in the article “NFA Proposes Guidance Amendments to Enhance Cybersecurity” in the December 9, 2018 edition of Bridging the Week.)

Compliance Weeds: Beginning in 2016, the Financial Crimes Enforcement Network of the US Department of Treasury requires covered financial institutions to file a suspicious activity report whenever a financial institution is targeted by a cyber-event where it knows, or has reason to suspect, the purpose was to effect transactions involving in aggregate US $5,000 or more in funds or other assets. A SAR filing is required for successful as well as unsuccessful attacks, and is encouraged for other cyber-incidents. Covered financial institutions include banks, broker-dealers, futures commission merchants, introducing brokers and mutual funds. (Click here for further details in the article “FinCEN Issues Advisory Saying Cyber Attacks May Be Required To Be Reported Through SARs” in the October 30, 2016 edition of Bridging the Week.)

For further information

Bag the Gag Orders Required by Respondents Settling SEC Enforcement Actions Requests Libertarian Think Tank in Federal Court Lawsuit:

Colorado Proposed Law Would Exempt Consumptive Tokens from State Securities Laws:

EU Banking and Markets Regulators Say European Financial Regulations Unevenly Applied to Cryptos or Not at All:

NFA Sets April 1 as Compliance Date for New ISSP Requirements:

Non-Member’s Placement of Matching Buys and Sells Constituted Wash Sales Says CBOT:

Norway Regulator Censures Exchange in Connection with Recent Default:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 12, 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.

© 2022 Katten Muchin Rosenman and Gary DeWaal. All Rights Reserved.