For Hong Kong lawyers who counsel clients in the digital currency space, a pair of enforcement actions within the past month by two of the major US agencies – the Securities and Exchange Commission ("SEC") and Commodity Futures Trade Commission ("CFTC") – bear watching. Given the major proportion of digital currency markets based in Greater China, the enforcement actions could foreshadow events that will arrive on the Chinese shores.
On 29 September 2017, the SEC charged two companies and their founder Maksim Zaslavskiy for violations of anti-fraud and registration provisions of the federal securities laws. This is the SEC's first charge against a company utilising the initial coin offering ("ICO") fundraising model.
According to the civil complaint, Zaslavskiy defrauded investors into contributing approximately US$300,000 in exchange for new digital tokens purportedly backed by real estate and diamonds. In fact, the SEC alleges that the ICO was essentially a sham. Allegedly, Zaslavskiy never actually created or issued any digital tokens, and his companies did not actually invest in real estate or diamonds as promised.
In similar fashion, on 21 September 2017, the CFTC charged a company and its founder Nicholas Gelfman with fraudulently soliciting approximately US$600,000 for a bitcoin trading strategy. According to the CFTC, the trading strategy was a sham, and Gelfman was essentially operating a Ponzi scheme that made payouts to certain investors from other customers' misappropriated funds.
Importantly, this action represents the first time the CFTC has asserted regulatory authority to police fraud in underlying bitcoin markets, as opposed to derivatives markets or leveraged trading. This potentially is a very significant development, as it indicates the CFTC's willingness to reach beyond its usual jurisdiction and assert a more aggressive theory of its regulatory reach.
More recently, Bloomberg reported on 2 October 2017, that the CFTC was making inquiries into the 21 June 2017 "flash crash" of Ethereum on Coinbase's GDAX trading platform. In the flash crash, Ethereum plummeted from US$365.79 to US$0.10 before recovering shortly thereafter. Reportedly, the CFTC is focusing its investigation on the role of margin trading, which allows traders to amplify bets using borrowed funds.
These enforcement actions by US authorities are occurring on somewhat contradictory theories advanced by the SEC and the CFTC: the SEC claims many digital currencies are "securities", while the CFTC claims they are also "commodities" under US law. Both agencies have taken a global view when it comes to personal jurisdiction over companies that transact business which could harm US investors. As the turf war between the two agencies continues, it is highly likely that the two agencies will take more adventurous enforcement actions to mark their jurisdiction in markets around the world. In doing so, it is highly likely that the SEC and the CFTC will target Chinese companies with increasing frequency. The CFTC already took the first step by sanctioning Bitfinex, a Hong Kong-based exchange, for offering leveraged trading without registering with the CFTC. Hong Kong attorneys who advise digital currency exchanges, traders, and other businesses need to monitor these first-of-their-kind enforcement actions closely, which may mark a trajectory that will eventually put Chinese companies within the agencies' cross-hairs in the near future.