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How Digital Asset Innovators Can Manage the Risks of White Collar Scrutiny in the US

Described as the "Wild West" by SEC Chairman Gary Gensler, the meteoric rise of digital assets like cryptocurrencies has disrupted the traditional financial ecosystem. The wave of enforcement actions brought by federal and state regulators in 2021 serves notice to both individuals and institutional players that they should proceed cautiously during 2022.

Although the regulatory landscape facing digital assets still remains murky, enforcement actions and public statements by the Department of Justice, federal financial regulators and state enforcement agencies in 2021 and early 2022 indicate that officials are attempting to bring clarity to laws that apply to offering, trading and lending of cryptocurrencies. Looking forward, institutional players seeking a foothold in this space should approach new endeavors with caution and develop strategies to minimize the risk associated with increased enforcement in an unclear and rapidly developing regulatory scheme.

A cryptocurrency is a form of digital asset that employs cryptography (methods by which complex mathematical computations secure information) to achieve functionality similar to that of traditional currencies, such as the inability to counterfeit or double-spend. Unlike traditional currencies, which are established and regulated by a sovereign's central bank, cryptocurrencies can be entirely anonymous, untraceable and sometimes incapable of being seized or frozen. These features, among others, make them attractive to those looking to evade the law and, thereby, a focus of law enforcement officials. 

The following provides an overview and analysis of the US regulatory bodies who have heightened their enforcement and scrutiny of cryptocurrencies in 2021.

 

United States Department of Justice

On October 6, 2021, Deputy Attorney General Lisa O. Monaco announced a new Department of Justice (the "DOJ") team designed to tackle complex crimes involving the use of cryptocurrencies. The National Cryptocurrency Enforcement Team (the "NCET") will comprise of prosecutors from the Department of Justice Criminal Division's Money Laundering and Asset Recovery Section ("MLARS"), the Computer Crime and Intellectual Property Section (the "CCIPS") and US Attorney offices. The NCET is designed to "identify, investigate, support, and pursue cases against cryptocurrency exchanges, infrastructure providers, and other entities that are enabling the misuse of cryptocurrency and related products to commit or facilitate criminal activity."1 On February 17, 2022, the DOJ announced the appointment of a first Director of the NCET.2

Deputy Attorney General Monaco's announcement of the NCET was notable for its focus on institutional players in addition to individual criminal actors. The announcement discussed "financial institutions" as a focus for increased investigative and prosecutorial focus, and it further indicated that cryptocurrency exchanges and infrastructure providers may themselves come under criminal scrutiny.

By the time the formation of the NCET was announced, the DOJ had brought dozens of high-profile actions. For example:

  • In June 2021, the US Attorney for the Northern District of Texas charged a man with operating an unlicensed money-remitting business by running a cash-to-cryptocurrency scheme in which he accepted large amounts of currency for conversion into digital assets without verifying the source of the currency. Over the course of a year, the man converted between $550,000 and $1.5 million of US currency into cryptocurrency. He pled guilty on June 29 and faces up to five years in federal prison.3
  • In July 2021, a man pled guilty in the Eastern District of New York for his participation in a cryptocurrency and securities fraud scheme related to two cryptocurrency platforms he created. The defendant falsely told investors that if they bought tokens on his platforms, they would be invested in cryptocurrency mining and other investments that would earn significant return. Instead, he directed the money to accounts he and others controlled and used the money for personal expenditures. He faces a maximum sentence of five years in prison.4
  • In August 2021, the US Attorney for the Northern District of Texas charged two founders of a cryptocurrency company with tax evasion related to their unregistered crypto token offering. They pled guilty in October to depriving the US government of more than $1.6 million in tax revenue.5 Their cryptocurrency company was also charged by the SEC with fraud and operating an unregistered digital asset exchange. Those charges were settled with an agreement that required an $8.3 million penalty.6
  • Most recently, the DOJ announced the seizure of a record $3.6 billion worth of bitcoin stolen in a cyber attack on an exchange. At the same time, the DOJ arrested two individuals allegedly connected with the laundering of these funds. The defendants laundered the bitcoin by using fictitious identities, computer programs that rapidly and automatically moved funds, darknet markets, and many other sophisticated laundering techniques.7

 

Securities and Exchange Commission 

An ongoing debate has been the scope of the Securities and Exchange Commission's (the "SEC") authority over cryptocurrencies, and 2021 has demonstrated that the SEC plans to place itself in the center of this area of enforcement. In remarks before the Aspen Security Forum on August 3, 2021, Chair Gary Gensler expressed his belief that many cryptocurrencies, and "most" nascent coins launched through Initial Coin Offerings ("ICO"), are securities.8 He emphasized the SEC's enforcement in the ICO space: "Over the years, the SEC has brought dozens of actions in [the ICO] area, prioritizing token-related cases involving fraud or other significant harm to investors. We haven't yet lost a case."9

When it comes to classification of cryptocurrencies as a commodity and/or a security, it is now well established that courts will apply the nearly 80-year-old test developed in SEC v. Howey.10 Recent developments have suggested that many, if not most, cryptocurrencies may fall within the definition of an "investment contract" as defined in Howey and that the SEC will therefore play a primary enforcement role in the landscape. With respect to debt-like instruments, the SEC has also invoked the test established by the Court in Reves v. Ernst & Young,11 which held that "a note is presumed to be a security unless it bears a strong ‘family resemblance' to certain judicially-crafted exceptions to notes that are not securities."12 The SEC has made it clear that while Congress considers legislation to address digital assets, it will continue to regulate through the application of the Howey and Reves tests in enforcement actions.13

In 2021, the SEC brought 20 enforcement actions related to cryptocurrencies, with the majority related to ICOs.14 The SEC has achieved a broad range of non-monetary relief against promoters of unregistered ICOs, including "undertakings that require issuers of digital asset securities to destroy tokens in their possession, request removal of tokens from trading platforms, publish the SEC's order on social media channels, and refrain from participating in future digital asset offerings."15

In perhaps the most well-known action, in December of 2020, the SEC sued Ripple Labs, Inc., and two of its executives, alleging that they had offered their novel cryptocurrency, Ripple (also known as "XRP"), to the market without registering it as a security.16 As the litigation proceeded in 2021, Ripple Labs vigorously argued in the media and before the court that Ripple is not a security and is therefore not subject to the regulation of the SEC. The case is expected to be a landmark test of the SEC's jurisdiction over cryptocurrencies.17

The SEC's recent enforcement activity extends well beyond the ICO space. In August, the SEC announced its first action involving Decentralized Finance ("DeFi") technology, which uses a secure distributed ledger to hold the assets rather than a traditional bank.18 The cease-and-desist order alleged that two top executives and their Cayman Islands company had conducted unregistered sales of securities through their offering of two tokens on a DeFi platform and misled investors by stating they had invested in car loans, when they had not.19

The SEC also targeted crypto lending platforms. In September, the SEC sent a Wells Notice to Coinbase in advance of its anticipated launch of a lending platform; Coinbase abandoned the endeavor as a result and, in a blog post by its CLO, indicated its frustration with the SEC's approach and unwillingness to share its reasoning.20 That same month, the SEC brought civil charges against a major online crypto lending and trading platform, along with its founder and a promoter.21 Those charges alleged that its "Lending Program" was in fact a fraudulent and unregistered offering and sale of a security. The Lending Program had investors lend bitcoin for a set "lock up" period and promised interest payments set by its proprietary "Trading Bot," which allegedly made money by taking advantage of bitcoin's high volatility.22 In December, the SEC announced that a judgment was entered against the promoter,23 who also pled guilty to related criminal charges brought by the DOJ in September.24

On February 14, 2022, the SEC charged a lending platform with failing to register the offers and sales of its retail crypto lending product.25 More significantly, the SEC also charged the lending platform with violating the registration provisions of the Investment Company Act of 1940, as amended (the "Investment Company Act") because it issued securities and held more than 40% of its total assets, excluding cash, in investment securities (including loans of crypto assets to institutional investors and investments in crypto asset trusts) without otherwise being exempted or excluded from the definition of an investment company or having sought an order from the SEC declaring the same or exempting it. To settle the SEC's charges, the lending platform agreed to pay a $50 million penalty, cease the unregistered offers and sales of its lending product, and attempt to bring its business into compliance with the applicable provisions of the Investment Company Act within 60 days. The lending platform also announced that it intends to register under the Securities Act of 1933, as amended, the offer and sale of a new lending product. The lending platform also agreed to pay an additional $50 million in fines to 32 states to settle similar charges.26

 

New York Office of the Attorney General

New York has emerged as the most active state enforcer of crypto-related laws.27 The New York Office of the Attorney General (the "NYAG") has pursued cryptocurrency enforcement through the New York state law regulating the offering of securities, the Martin Act, making it clear that it considers cryptocurrencies to be securities under New York law.

In February of 2021, the NYAG brought a civil enforcement action against two major institutional players for allegedly making false public statements regarding the reserves backing their stablecoin. The NYAG banned them from trading in New York State and obtained $18.5 million in fines.28 In October 2021, the NYAG ordered two cryptocurrency lending platforms to cease operating in New York State because they were allegedly in violation of the Martin Act for offering interest-bearing products that are unregistered securities, for operating as an unregistered broker-dealer in offering these products, and for dealing in cryptocurrencies that are commodities under the Martin Act.29

Several other state enforcement agencies have brought crypto-related enforcement actions, with heightened activity by Kentucky, Texas, Vermont, Alabama and New Jersey.30 Crypto lending platforms are an area of particular interest as recent action by the SEC and 32 states shows.31

 

Commodity Futures Trading Commission

The CFTC has been active in the cryptocurrency space since 2015, when it first determined the proper definition for cryptocurrencies as "commodities" under the Commodity Exchange Act. In October, acting Chairman of the CFTC, Rostin Behnam stated that his agency should be the primary agency overseeing cryptocurrency markets, rather than the SEC. He claimed that, of the $2.7 trillion cryptocurrency market, "nearly 60% [of cryptocurrencies] were commodities," and said that he believed the CFTC should emerge as the primary regulator in the space.32 Notably, his remarks directly contradicted those of SEC Chairman Gensler, who—endorsing the words of his predecessor, Jay Clayton—claimed that he "hadn't seen many [crypto] tokens that didn't meet that securities test."33

The CFTC has been increasing the frequency and expanding the scope of its enforcement actions in the last year. In 2021, it more than doubled the seven retail fraud enforcement cases it brought in 2020.34 In fact, in a single day, on September 29, 2021, the CFTC filed complaints against 14 different cryptocurrency trading platforms, demanding they cease and desist from violations of the Commodity Exchange Act.35 This announcement came only a day after it had announced a record-breaking $1.25 million civil penalty resulting from a settlement with one of the leading international cryptocurrency exchanges.36 The CFTC also joined other agencies in bringing actions against two cryptocurrency platforms for making allegedly false statements regarding the backing of their reserves as well as for operating off-exchange retail commodity transactions and failing to register as a futures commission merchant ("FCM").37

The CFTC has also been charging new types of cryptocurrency cases. For example, it filed its first complaint related to the manipulation of cryptocurrency markets in March, when it charged the developer of a popular antivirus company and one of his former employees with pump-and-dump schemes in various cryptocurrencies. According to the complaint, the developer and his former employee acquired large holdings in various cryptocurrencies, promoted them on social media, and then sold them at inflated prices to achieve more than $2 million in profit.38

 

Department of the Treasury: Financial Crimes Enforcement Network

The Treasury's Financial Crimes Enforcement Network ("FinCEN") has also played a role in crypto enforcement, often operating in tandem with other agencies.39 In August, FinCEN, in coordination with the CFTC, assessed a civil penalty of $100 million against one of the largest cryptocurrency derivatives exchanges for violations of the Bank Secrecy Act and FinCEN's related regulations.40

 

Looking Ahead to a New Year of Crypto Enforcement

The momentum of federal and state cryptocurrency enforcement activity continued to build throughout 2021, and clients pursuing a new venture in the cryptocurrency space should be vigilant of the rapidly developing regulatory environment. Absent legislative action from Congress, agencies may continue their enforcement through broad interpretation of their existing authority. While regulators publicly suggest that proactive engagement with regulators can minimize the risk of enforcement, this can be a difficult prospect when multiple agencies with unknown scopes of authority seek to regulate the same space. In addition, as Coinbase reported,41 proactive engagement with the SEC did not stop the SEC from issuing Coinbase a Wells Notice after nearly six months of engaging with the SEC staff with respect to its Lend product. 

A robust, proactive compliance program with frequent risk assessments remains one of the best methods to minimize the possibility that crypto-related projects conflict with the latest regulatory and enforcement developments. Companies should determine early whether a new digital asset might be characterized as a security, and that assessment should be revisited on a regular basis as the case law and regulatory guidance develops. Comprehensive KYC/AML programs tailored to detect cryptocurrency-specific suspicious activity will not only minimize the risk of fraud, but also demonstrate to regulators that the company takes its compliance seriously. Further, lending platforms should regularly assess whether they are in compliance with the Investment Company Act. 

If you choose to engage with the SEC or any other government agency, please consider your choice of counsel carefully to ensure you have a robust plan in place to make the first outreach, including establishing clear goals for this engagement. Counsel should also vet all public statements related to a product's functionality or suitability, particularly those concerning the reserves backing a stablecoin or other product.

 

1 Press Release, DOJ, "Deputy Attorney General Lisa O. Monaco Announces National Cryptocurrency Enforcement Team" (Oct. 6, 2021).
2 Press Release, DOJ, "Justice Department Announces First Director of National Cryptocurrency Enforcement Team" (Feb. 17, 2022). 
3 Press Release, DOJ, "‘Doctor Bitcoin' Pleads Guilty to Illegal Cash-to-Crypto Scheme" (June 29, 2021).
4 Press Release, DOJ, "US Promoter of Foreign Cryptocurrency Companies Pleads Guilty for Role in Multimillion-Dollar Securities Fraud Scheme" (July 30, 2021).
5 Press Release, DOJ, "Founders of Crypto ICO Plead Guilty to Tax Evasion After Raising $24 Million from Investors" (Oct. 12, 2021).
6 Press Release, SEC, "SEC Charges Dallas Company and Its Founders with Defrauding Over 13,000 Investors in Unregistered Offering and Operating Unregistered Digital Asset Exchange" (Aug. 29. 2019).
7 Press Release, DOJ, "Two Arrested for Alleged Conspiracy to Launder $4.5 Billion in Stolen Cryptocurrency" (Feb. 8, 2022).
8 Gary Gensler, "Remarks Before the Aspen Security Forum" (August 3, 2021).
9 Gary Gensler, "Remarks Before the Aspen Security Forum" (August 3, 2021). The SEC's record may have been broken in early November 2021, when a jury in Connecticut disagreed with the SEC's characterization of a digital asset. In SEC v. Garza, GAW Miners, LLC, and ZenMiner, LLC, 3:15-cv-1760 (D. Conn. 2015), the SEC argued that the defendant's products–which sold a stake in non-existent crypto-mining hardware (computers that generated Bitcoin)–were unregistered securities. The jury disagreed, finding that none of the products were securities.
10 328 US 293 (1946). 
11 494 US 56 (1990).
12 Gurbir Grewal, 2021 SEC Regulation Outside the United States—Scott Friestad Memorial Keynote Address.
13 For example, when the President's Working Group on Financial Markets ("PWG") released a report on the federal government's approach to, among other digital assets, stablecoins, Chairman Gensler made clear that the SEC would not wait for Congress to regulate stablecoins. See Gary Gensler, President's Working Group Report on Stablecoins (Nov. 1, 2021) ("While Congress and the public evaluate this report, we at the SEC and our sibling agency, the Commodity Futures Trading Commission, will deploy the full protections of the federal securities laws and the Commodity Exchange Act to these products and arrangements, where applicable.").
14 See Cornerstone Research, SEC Cryptocurrency Enforcement 2021 Update (2022). For examples of ICO actions by the SEC in 2021, see, e.g., Press Release, SEC, "SEC Charges ICO Issuer and CEO With Fraud and Unregistered Securities Offering" (June 22, 2021), (alleging ICO issuer and its CEO made materially false and misleading statements relating to an unregistered offer and sale of digital asset securities); Press Release, SEC, "SEC Charges Poloniex for Operating Unregistered Digital Asset Exchange" (Aug. 9, 2021), (obtaining a settlement of more than $10 million over allegations that company operated an unregistered exchange); Press Release, SEC, "SEC Charges Latvian Citizen With Digital Asset Fraud" (Dec. 2, 2021), (alleging Latvian citizen fraudulently offered unregistered securities in multiple schemes involving digital assets). 
15 Gurbir Grewal, 2021 SEC Regulation Outside the United States—Scott Friestad Memorial Keynote Address (Nov. 8, 2021).
16 Press Release, SEC, "SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering" (Dec. 22, 2020).
17 Heading into 2022, discovery in the Ripple litigation continues, and this year has already presented significant decisions on discovery issues unrelated to the merits of the case. See, e.g., Opinion and Order, SEC v. Ripple Labs, Inc., 20-CV-10832 (AT) (SN), 2022 BL 12871 (S.D.N.Y. Jan. 13, 2022).
18 Press Release, SEC, "SEC Charges Decentralized Finance Lender and Top Executives for Raising $30 Million Through Fraudulent Offerings" (Aug. 6, 2021).
19 Id.
20 Paul Grewal, The SEC has told us it wants to sue us over Lend. We don't know why., THE COINBASE BLOG (Sept. 7, 2021).
21 Press Release, SEC, "SEC Charges Global Crypto Lending Platform and Top Executives in $2 Billion Fraud" (Sept. 1, 2021).
22 See Complaint, SEC v. BitConnect et al, S.D.N.Y. Dkt. No. 1:21-cv-7349 (JGK) (S.D.N.Y. Sept. 1, 2021) ¶¶ 49-73, 168-79.
23 Litigation Release, SEC, "SEC Obtains Judgments Against Bitconnect's Lead National Promoter and His Company for Antifraud and Registration Violations" (Dec. 9, 2021). 
24 Press Release, DOJ, "Director and Promoter of BitConnect Pleads Guilty in Global $2 Billion Cryptocurrency Scheme" (Sept. 1, 2021).
25 BlockFi Lending LLC, Securities Act Release No. 11029, Investment Company Act Release No. 34503 (Feb. 14, 2022).
26 See Press Release, SEC, "BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product" (Feb. 14, 2022).
27 This is likely due, at least in part, to the state's attempt at a comprehensive regulatory structure for all crypto-related companies operating within the state, who must obtain a "BitLicense" through a detailed application and disclosure process. See New York Department of Financial Services, Virtual Currency Business Activity, (last visited Feb. 10, 2022).
28 Press Release, New York Attorney General James.
29 See Press Release, New York Attorney General James, "Attorney General James Directs Unregistered Crypto Lending Platforms to Cease Operations in New York, Announces Additional Investigations" (Oct. 18, 2021).
30 Joe Light, Crypto Faces Existential Threat as Crackdown Gathers Steam, Bloomberg (Sept. 22, 2201).
31 For example, in July 2021, all five states initiated actions against BlockFi alleging its interest-bearing accounts are unregistered securities in violation of state laws. See Joe Light, Crypto Accounts Yielding 7% Spur Scrutiny as States Warn of Risk, Bloomberg (Sept. 2, 2021). In September 2021, Alabama, Kentucky, New Jersey, and Texas announced actions against Celsius Network for similar products. See Joe Light, States Act Against Celsius Network for Unregistered Products, Bloomberg (Sept. 17, 2021). Of the $100 million settlement announced on February 14 by the SEC regarding a crypto lending platform, $50 million will go to settling claims with 32 states. See Press Release, SEC, "BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product" (Feb. 14, 2022). 
32 Nikhilesh De, CFTC Should Be Crypto's ‘Primary Cop,' Acting Chairman Says, Coindesk (Oct. 27, 2021).
33 Squawk Box, SEC Chair Gary Gensler on His Vision for Cryptocurrency Regulation, CNBC (Aug. 4, 2021).
34 Press Release, CFTC, "CFTC Division of Enforcement Issues Annual Report" (Dec. 1, 2020).
35 Press Release, CFTC, "CFTC Charges 14 Entities for Failing to Register as FCMs or Falsely Claiming to be Registered" (Sept. 29, 2021).
36 Press Release, CFTC, "CFTC Imposes A $1.25 Million Penalty against Kraken for Offering Illegal Off-Exchange Digital Asset Trading and Failing to Register as Required" (Sept. 28, 2021).
37 Press Release, CFTC (Oct. 15, 2021).
38 Press Release, CFTC, "CFTC Charges Two Individuals with Multi-Million Dollar Digital Asset Pump-and-Dump Scheme" (Mar. 5, 2021).
39 Treasury's Office of Foreign Asset Control has also brought actions with in tandem with other agencies. See, e.g., Enforcement Release, Department of the Treasury, "OFAC Enters Into $507,375 Settlement with BitPay, Inc. for Apparent Violations of Multiple Sanctions Programs Related to Digital Currency Transactions" (Feb. 18, 2021); Press Release, Department of the Treasury, "Treasury Takes Robust Actions to Counter Ransomware" (Sept. 21, 2021). The Office of the Comptroller of the Currency ("OCC") did not bring any crypto specific actions in 2021 though remains involved in this area. It announced its first crypto enforcement action in February of 2020, when it entered into a consent order with M.Y. Safra Bank, a Federal Savings Bank located in New York City, which it alleged was opening accounts for "Digital Asset Customers," including money service businesses, "without sufficient consideration of the [Bank Secrecy Act]/[Anti-Money Laundering] risks," and that it had begun to service these customers without adequate notice to the regulators of its intent to deviate from its business plan. The consent order included many actions the bank must take to ensure it has sufficient compliance, reporting, auditing and investigative procedures. See M.Y. Safra Bank, FSB, AA-NE-2020-5 (Jan. 30, 2020), .
40 Press Release, "FinCEN, FinCEN Announces $100 Million Enforcement Action Against Unregistered Futures Commission Merchant BitMEX for Willful Violations of the Bank Secrecy Act" (Aug. 10, 2021).
41 Paul Grewal, The SEC has told us it wants to sue us over Lend. We don't know why., THE COINBASE BLOG (Sept. 7, 2021)

 

Stephen Hogan-Mitchell (White & Case, Law Clerk, New York) contributed to the development of this publication.

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