by T. GormanPosted on Posted in SECActions

The Financial Stability Oversight Council released its Report on Digital Assets Financial Stability Risks and Regulation on October 3, 2022 (here). The Report was released on October 3, 2022 (here) pursuant to Section 6 of President Biden’s Executive Order 14067 on “Ensuring Responsible Development of Digital Assets.” The Report discusses financial risks posed by the assets, enforcement of regulations, regulatory gaps and future steps.

Risks: A key point in the Report is risk. It notes, in this regard, that crypto asset activity can present risks for the stability of the U.S. financial system. This may result, for example, from rapid growth in the area since it is not tied to appropriate regulation and enforcement.

There has been rapid growth in the area of crypto assets, according to the Report. At the same time there is significant interconnectedness. Participants in the crypto ecosystem have been exploring avenues of connection. In addition, trading platforms offer a significant potential for interconnecting the assets with traditional assets and trading platforms. Consumers have also added to crypto asset activities according to the Report. All of this can aid risk mitigation.

There are, however, crypto asset activities that have amplified instability. Those include:

1) A the lack of risk controls to protect against runs and excessive leverage

2) Prices that are driven by speculation and often suffer rapid declines

3) Many crypto-asset firms or activities have sizable interconnections with others that have risky business profiles and opaque positions, and

4) Operational risks may arise from the concentration of key services or other vulnerabilities related to distributed ledger technology

The vulnerabilities are at least in part attributable to the choices made by market participants, issuers and platforms.

Enforcement: While crypto began with an “off the grid focus,” many operating in the area are now more interested in regulation. Indeed, enforcement of is key. Not infrequently crypto-assets are marketed and sold in violation of the securities laws because they are offered and sold without the benefit of registration. In other instances, the marketing may focus on assuring investors of safety and through claims such as regulatory backing which in fact does not exist. Consumers may also be confused by what regulation actually governs crypto-assets.

Gaps: Another key point is in the Report is regulatory gaps. There is no doubt that while the existing regulation covers large portions of the crypto-assert world, and at times there may be overlapping regulation, there are also gaps. Three examples illustrate the point:

1) Spot markets for crypto-assets that are not securities are subject to little regulation although, in some instances agencies such as the CFTC may have jurisdiction.

2) Frequently crypto-asset businesses do not have a consistent or comprehensive regulatory framework.

3) In some instances, crypto-asset trading platforms have proposed offering retail customers direct market access by vertically integrating services with intermediaries such as broker-dealers or FCMs.

Recommendations

The Report notes that large parts of the crypto-asset ecosystem are currently subject to regulation. The Counsel recommends that members take this into consideration and emphasize the importance of continued enforcement of the existing regulatory scheme.

The gaps must also be considered. These areas can be addressed, for example, by passing legislation that includes rulemaking authority for federal financial regulators over the spot market for assets that are not securities. Steps can also be taken to address regulatory arbitrage including coordination, legislation regarding certain risks and through supervision. The Council, in addition, recommend bolstering members’ capacities related to data, analysis, monitoring, supervision and regulation. See also Gary Gensler, Statement on Financial Stability Oversight Council’s Report on Digital Asset Financial Stability Oversight Council Open Meeting, October 3, 2022 (here).

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by T. GormanPosted on Posted in SECActions

After filing what must have been a record setting number of new proceedings for one week, as the government fiscal year came to a close, the Commission filed just one new action last week. That action, however, may well have created more publicity for the agency, and done more to advocate its view of crypto coins as a security than anything that has been done to date – the identity of the respondent was celebrity Kim Kardashian. While other actions are listed on the Commission website under Litigation Releases, they are for either previously filed cases actually filed prior to fiscal year end or the announcement of a judgments.

SEC Enforcement – Filed and settled actions

Last week the Commission filed 1 civil injunctive action and no administrative proceedings, exclusive of 12j, default, conflicts (which are included in the tabulations of cases). tag-a-long and other similar proceedings.

Touting: In the Matter of Kimberly Kardashian, Adm. Proc. File No. 3-21197 (October 3, 2022). Ms. Kardashian was retained to promote a crypto token called EMAX. She was paid $225,000 to promote the token. The tokens were promoted beginning in May 2021 in social media and marketing material. Ms. Kardashian also posted about the coins on her Instagram account which included an introductory video. In the advertising materials, the company that issued the coins assured purchasers that the coins would be traded in a secondary market. The marketing materials also discussed the management of the company. Prior to the EMAX promotion the Commission had issued the DAO Report of Investigation on July 25, 2017 stating its views on crypto and what constitutes a security. The report defined the test for determining if an investment contract is a security under the Supreme Court’s determination in SEC v. Howey, 328 U.S 293 (1966). It also discussed what has now become known as the “ecosystem” surrounding the crypto coins – the efforts of others part of the Howey test that creates the hoped for profits with the pooled investor money. While it is clear that Ms. Kardashian promoted the coin as promised, what she did not do is disclose that she was paid to promote the coins and the amount. There was thus a violation of Section 17(b) of the Securities Act. Ms. Kardashian resolved the proceedings by cooperating with the Commission and agreeing not to receive any form of compensation for three years for promoting a crypto asset security. She also agreed to continue cooperating with the agency. She also consented to the entry of a cease-and-desist order based on the Section cited in the Order. In addition, Ms. Kardashian will pay disgorgement of $250,000, prejudgment interest of $10,415.35 and a $1 million penalty.

Cherry picking: SEC v. Kellen, Civil Action No. 2:20-cv-03861 (C.D. Cal.) is a previously filed action in which the Court entered a final judgment by consent against defendant Donald. J. Kellen on September 16, 2022. The complaint alleged that over a three-year period, beginning in May 2012, Defendant used an omnibus account to cherry pick profitable trades. The judgment enjoins Defendant from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). It requires, in addition, that Defendant pay disgorgement of $51,157, prejudgment interest of $3,195 and a penalty of $25,000. In a separate administrative proceeding, the Commission barred Defendant from the securities business. See Lit. Rel. No. 25551 (October 6, 2022).

Financial fraud: SEC v. Davis, Civil Action No. 14-cv-01528 (S.D.N.Y.) is a previously filed action in which the Court entered a final judgement by consent against defendant Steven Davis, then an executive and attorney with Dewey & LeBoeuf, LLP. The underlying complaint alleged that in a $150 million private placement of bonds for the law firm, Defendant defrauded purchasers by putting false financial statements in the private placement memorandum. The final judgement prohibits future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, Defendant also must pay disgorgement of $86,250 and prejudgment interest of $8,779.71. The judgment suspends Defendant’s right to appear and practice before the Commission as an attorney. See Lit. Rel. No. 25549 (October 4, 2022),.

FINCEN

Beneficial interest: The Financial Crimes Enforcement Network issued its first rule defining the term beneficial interest, according to a release dated September 29, 2022 (here).

Hong Kong

Remarks: Julia Leung delivered the keynote speech at ASIGMA Tech and Ops Conference, October 6, 2022, titled “Resilience and innovation in times of change. Here remarks are available here.

Singapore

Report: The Monetary Authority of Singapore announced a new five-pronged strategy to counter the financing of terrorism in a release dated October 7, 2022 (here).

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