On September 27, 2018, the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) filed parallel actions in federal court against an internet dealer that sold “contracts for difference” (CFD) based on securities and commodities margined with bitcoin. The actions, which were assisted by the Federal Bureau of Investigation and the Department of Justice, signal continued coordination among federal agencies to police market activity involving financial transactions in cryptocurrencies.
The CFTC and SEC filed separate actions in federal district court for the District of Columbia against 1pool Ltd. (a/k/a 1Broker) and its chief executive officer and owner, Patrick Brunner, for a number of violations under the Commodity Exchange Act (CEA), Securities Act, and Exchange Act, relating to the defendants’ sale of CFDs over the internet to U.S. customers. All transactions were margined and settled in bitcoin. The platform allegedly failed to collect any identifying information about its customers that would satisfy regulatory know-your-customer or customer identification (KYC/CIP) requirements or demonstrate the ability of its retail customers to meet the discretionary investment thresholds required by federal securities and commodities laws. Rather, to open a trading account, customers needed only to provide an email address and username.
The CFTC and the SEC’s complaints each target different aspects of 1pool’s business. The SEC’s action covers certain of 1pool’s CFDs that were tied to the value of underlying securities, market indices, or other financial assets, which the SEC classified as security-based swaps. The CFTC’s case, in turn, seeks to regulate 1pool’s commodity-backed CFDs as retail commodity transactions. Both actions allege that the defendants unlawfully failed to register with each agency (as a broker-dealer or futures commission merchant, respectively) and conducted transactions in the United States outside of a registered exchange with counterparties who were not eligible contract participants as defined in the CEA. The SEC additionally alleges violation of Securities Act registration requirements applicable to security-based swaps offered or sold to such counterparties. The CFTC additionally alleges that the defendants violated regulations requiring futures commission merchants to implement the requisite supervisory and KYC/CIP procedures to prevent money laundering and other misconduct.
The agencies seek a range of penalties. The SEC’s complaint requested typical remedies of disgorgement, civil penalties, and a permanent injunction against the specific misconduct alleged against 1pool. The CFTC went beyond this to also seek a permanent registration and trading ban and restitution to customers of 1pool.
The announced actions mark a critical point of regulatory coordination between the SEC and CFTC. As recently as June 2018, the two agencies entered into a joint Memorandum of Understanding to promote efficiency in rule-making, regulatory oversight, and enforcement for swaps and security-based swaps. The MOU specifically promoted consultation and coordination “enforcement actions, investigations, or sanctions that could adversely impact an entity, product, or market under the other [agency’s] jurisdiction.” 1pool’s business model placed it squarely within the jurisdiction of each agency. The continued growth of cryptocurrency-related derivatives transactions are likely to provide additional opportunities for coordinated regulatory and enforcement actions by both agencies.
In addition, the actions show a continued focus by the SEC on policing security-based swaps offered to retail investors, which had previously been the focus of enforcement actions in 2016 against Forcerank LLC and Equidate Inc. and in 2015 against Sand Hill Exchange.