On December 20, 2018, the U.S. Securities and Exchange Commission (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) released its 2019 Examination Priorities.  The six themes for this year’s priorities are:  retail investors (including seniors and those saving for retirement), compliance and risk in registrants responsible for critical market infrastructure (clearing agencies, transfer agents, national securities exchanges and Regulation SCI entities), oversight of the Financial Industry Regulatory Authority and Municipal Securities Rulemaking Board, digital assets, cybersecurity and anti-money laundering.  The only new theme for 2019 compared to 2018 is digital assets, which we take to imply a plan to more closely—and substantively—regulate investment advisers and broker-dealers involved with this asset class.  The 2019 priorities also more explicitly than the 2018 priorities describe specific practices that OCIE found concerning in examinations of those entities, many of which involved failure to adequately safeguard client assets and the adequacy of disclosures of conflicts of interest.  We expect to see a corresponding focus in Enforcement Division investigations and cases on these issues as a result.
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On November 28, 2018, the Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) identified for the first time digital currency addresses associated with sanctioned persons.  The newly sanctioned individuals, Iran-based Ali Khorashadizadeh and Mohammad Ghorbaniyan, were accused of converting digital currency payments into Iranian rial as part of a widespread ransomware scheme.  Since 2015, the ransomware scheme (known as “SamSam”) has infected the data networks of corporations, hospitals, universities, and government agencies.  According to OFAC’s announcement, the identified bitcoin addresses were used with over 40 digital currency exchangers to process more than 7,000 illicit transactions in bitcoins worth millions of U.S. dollars.
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On November 16, 2018, the U.S. Securities and Exchange Commission (“SEC”) Division of Corporation Finance (“Corp. Fin.”), Division of Investment Management, and Division of Trading and Markets issued a joint public statement on “Digital Asset Securities Issuance and Trading.”  The public statement is the latest in the Divisions’—and the Commission’s—steady efforts to publicly outline and develop its analysis on the application of the federal securities laws to initial coin offerings (“ICOs”) and certain digital tokens.  These efforts have combined a series of enforcement proceedings with public statements by Chairman Jay Clayton and staff, including a more detailed statement of the SEC’s analytical approach in Corp. Fin. Director William Hinman’s speech on digital assets in June 2018.
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On November 8, the Securities and Exchange Commission (“SEC”) imposed a cease-and-desist order against Zachary Coburn for causing his former company, EtherDelta, to operate as an unregistered securities exchange in violation of Section 5 of the Securities Exchange Act of 1934 (“Exchange Act”).  Notably, EtherDelta, a trading platform specializing in digital assets known as Ether and ERC20 tokens,[1] was not operated like a traditional exchange with centralized operations, as there was no ongoing, active management of the platform’s order taking and execution functions. Instead, EtherDelta was “decentralized,” in that it connected buyers and sellers through a pre-established smart contract protocol upon which all operational decisions were carried out.

In the SEC’s view, EtherDelta met Exchange Act Rule 3b-16(a)’s definition of an exchange notwithstanding the lack of ongoing centralized management of order taking and execution.  Robert Cohen, the Chief of the SEC’s Cyber Unit within the Division of Enforcement stated after the order’s release, “The focus is not on the label you put on something . . . The focus is on the function . . . whether it’s decentralized or not, whether it’s on a smart contract or not, what matters is it’s an exchange.” This functional approach echoes prior SEC guidance and enforcement actions in the digital asset securities markets in emphasizing that the Commission will look to the substance and not the form of a market participants’ operations in evaluating their effective compliance with U.S. securities laws.
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On November 2, the SEC’s Enforcement Division released its annual report detailing the facts and figures of its enforcement efforts in fiscal year 2018.  At first blush, this year’s report looks strikingly similar to those from recent years, as the headline numbers in most categories are nearly indistinguishable from 2015, 2016, and 2017.  This consistency may be surprising given that 2018 is the first such report reflecting exclusively the enforcement priorities of the Commission since it was reconstituted under Chair Jay Clayton.

But a closer examination of the report, including the components feeding into the top-line facts and figures and commentary by Division co-directors Stephanie Avakian and Steven Peikin, reveals a clear shift in priorities by the Division.  These range from a philosophical shift in its mission to the reallocation of resources during a hiring freeze.  We address here the most notable of these subtle but important changes. 
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On September 26, 2018, a federal court in the District of Massachusetts found that virtual currencies are a commodity under the Commodity Exchange Act, 7 U.S.C. § 1 et seq, (“CEA”). This marks the second time that a court has accepted the Commodity Futures Trading Commission’s (“CFTC”) position and upheld the agency’s authority to regulate unleveraged and unmargined spot transactions in virtual currency under the agency’s anti-fraud and manipulation enforcement authority.  Most notably, however, the reasoning behind its decision potentially expands the scope of the CFTC’s oversight of the market.
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Over the past year, the U.S Securities and Exchange Commission (“SEC”) has increasingly scrutinized initial coin offerings (“ICO”) and certain digital assets.  On September 20, 2018, the SEC’s Enforcement Division co-Director, Stephanie Avakian, gave a speech in which she addressed the Division’s approach to dealing with these new forms of tradeable assets.  This speech came only days after the SEC settled its first case charging an unregistered broker-dealer for facilitating the sale of digital tokens from several ICOs since the 2017 DAO Report.  In her speech, Avakian provided three key insights into the Division’s enforcement strategy.
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On Tuesday, September 11, 2018, Judge Raymond J. Dearie of the Eastern District of New York issued a decision holding that Initial Coin Offerings (“ICO”) may qualify as securities offerings and therefore be subject to the criminal federal securities laws.  This ruling came as two U.S. regulators—the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”)—announced separate actions under securities laws against companies engaged in the cryptocurrency marketplace, including the sale of digital tokens.  As the popularity of cryptocurrencies grows and businesses and entrepreneurs increasingly turn to ICOs to raise capital, these developments may serve as guideposts for how cryptocurrencies and ICOs will be viewed by courts and federal regulators in cases to follow.
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Over recent months, numerous state regulators, including in Massachusetts, Texas, and New Jersey, have been exercising greater oversight of cryptocurrency businesses.[1]  On April 17, 2018, the office of the New York Attorney General Eric Schneiderman (“NYAG”) launched the Virtual Markets Integrity Initiative, which will seek information from various platforms that trade cryptocurrencies to better protect consumers.  The initiative responds to concerns that cryptocurrency trading platforms may not provide consumers with the same information available from traditional exchanges.  As part of the initiative, the NYAG’s Investor Protection Bureau sent thirteen major cryptocurrency trading platforms questionnaires relating to internal policies, controls, and best practices.  The Bureau intends to consolidate and disseminate to consumers the information it receives.
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On March 27, 2018, Massachusetts Secretary of State William Galvin announced that the state had ordered five firms to halt initial coin offerings (“ICOs”) on the grounds that the ICOs constituted unregistered offerings of securities but made no allegations of fraud.  These orders follow a growing line of state enforcement actions aimed at ICOs.

This was not Massachusetts’s first foray into regulating ICOs.  On January 17, 2018 the state filed a complaint alleging violations of securities and broker-dealer registration requirements against the company Caviar and its founder for an ICO that sought to create a “pooled investment fund with hedged exposure to crypto-assets and real estate debt.”


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