There is a gathering storm in the cryptocurrency universe, and traders must attune themselves to the risks.Until recently, many traders had operated under the assumption that digital currency trading was beyond the reach of U.S. regulators. This mindset, in turn, precipitated a virtual free-for-all on certain digital currency exchanges, with various traders deploying strategies that would never pass muster in more-established markets. But the view perpetuated by some traders of the digital currency arena as an outlaw paradise was always wrong. While strong jurisdictional defenses may be available for traders and purveyors of initial coin offerings in enforcement actions brought by the U.S. Commodity Futures Trading Commission (CFTC) and U.S. Securities and Exchange Commission (SEC), respectively, the same cannot be said for U.S. Department of Justice (DOJ) criminal actions.
The CTFC and SEC Assert Jurisdiction
It had previously been predicted that the unprecedented interest in cryptocurrency investment and trading would produce a regulatory scrum, with the CFTC and SEC jockeying for jurisdictional supremacy.And, by now, most sophisticated traders are aware that the CFTC has classified digital currency as a commodity and purported to assert broad anti-fraud jurisdiction over cryptocurrency transactions on that basis.Likewise, the SEC signaled in the now-notorious DAO report and other contexts, including recent enforcement actions, that digital currency offerings will, in many instances, be regarded as subject to U.S. securities laws and SEC jurisdiction.These regulatory stances are expected to be the subject of litigation this year – indeed, our firm is presently involved in two matters concerning the scope of the CFTCs jurisdiction over commodity transactions outside the realm of derivatives.
Enter the DOJ?
While many commentators and practitioners are understandably focused on whether- and if so, to what degree – the CFTC and SEC would assert jurisdiction over cryptocurrency enterprises, a much graver threat looms for traders who pressed the envelope on digital currency exchanges: criminal prosecution. Given the pervasive public interest in and, according to many reports, rampant misconduct rippling through cryptocurrency exchanges, it is only a matter of time before the DOJ pursues indictments and extraditions, much as it did last year against BTC-e and Alexander Vinnik. And when it does, the type of jurisdictional defenses against CFTC and SEC enforcement actions may be of little help: the DOJs anti-fraud authority is not constrained to any particular subset of financial instruments or the laws that traditionally govern the securities and derivatives markets. Nor would limiting trading to extraterritorial or offshore exchanges provide a reliable safe harbor.To ground jurisdiction, the DOJ need only identify a sufficient U.S. nexus, such as a U.S.-based victim or effects on U.S. commerce.And while various foreign exchanges have sought to mitigate the risk of DOJ scrutiny by purporting to bar U.S.-based parties, given the anonymous trading regimes in place at many digital exchanges, foreign traders may not be able to reliably exclude the risk of dealing with U.S. counterparties.
Traders in the Crosshairs
Just as the rise of algorithmic trading prompted the DOJ to send a message by pursuing a novel (and dubious) criminal prosecution against a futures trader, so too will the ongoing paradigm shift toward cryptocurrency trading inevitably compel the DOJ to take action – and, very likely, on a grander scale commensurate with public interest. Considering that cryptocurrency stories have populated the front pages of most major newspapers on a near-daily basis for months on end, traders should brace for a significant wave of prosecutions. And for traders already confronting questions from exchanges and regulators about trading practices, there are important lessons to be gleaned from the recent precedent arising from the futures space.
One lesson, in particular, warrants particular attention. Perhaps not surprisingly, many traders analyze regulatory inquiries from a transactional perspective, weighing the potential costs of financial settlements and temporary trading bans against the risks of longer-term distraction and legal fees. Often lost in the analysis is the very real threat that capitulation will usher in much graver consequences in the form of criminal indictment.But this should be the primary concern that informs all other decisions in this context. Indeed, if the DOJ road map for prosecutions in the futures industry is any guide, settling enforcement actions commenced by exchanges and civil regulators like the CFTC and SEC may well have the perverse effect of increasing the risk of follow-on criminal prosecution.In other words, traders who think they are buying peace may later find that it comes at the cost of their freedom.
Ultimately, for cryptocurrency traders subject to regulatory scrutiny, the only shelter in the prosecutorial storm to come will be an aggressive defense.
Kobre & Kim is a disputes and investigations law firm focused exclusively on matters relating to fraud and misconduct, with a proven track record of driving results for clients by aggressively defending against regulatory and criminal charges. David H. McGill is a litigator at the firm, where he acts as lead counsel for companies and individuals in disputes involving complex financial products and technologies. He has particular experience in conducting discrete internal investigations that arise from regulatory allegations and in defending against government enforcement actions by the U.S. SEC, DOJ and CFTC.
Benjamin J.A. Sauter is also a litigator at Kobre & Kim. He routinely represents companies in high-stakes litigation involving commodities, futures, swaps, and other securities and derivatives. His representations often involve clients facing U.S. regulatory and criminal enforcement proceedings.
Mr. McGill and Mr. Sauter regularly represent clients in digital currency disputes and are members of the Digital Currency & Ledger Defense Coalition.
