California App Developer Settles SEC and CFTC Charges for Improper Sales of Derivatives
A California app developer and its Philippines-based affiliate settled SEC and CFTC charges (see here and here, respectively) for improper sales of swaps and security-based swaps.
Respondents offered "a phone application allowing people to conduct financial transactions through contracts memorialized on the Bitcoin blockchain." The CFTC alleged that the mobile application allowed users to gain exposure to securities, foreign currencies and other assets. The CFTC explained that the application involved customers acquiring Bitcoin in the amount of the desired exposure, which was then posted as collateral.
According to the Orders, the respondents initially offered the transactions to U.S. customers and through the U.S.-based entity, but later sought to restrict their activities to transactions between the Philippines-based affiliate and non-U.S. customers. However, the SEC found that the Philippines-based corporation still entered into seven contracts with five individuals in the United States.
The SEC found that the firms violated Securities Act Section 5(e) ("Prohibitions Related to Interstate Commerce and Mail") and SEA Section 6(l) ("National Securities Exchanges"). The CFTC found that the firms violated CEA Sections 2(e) ("Eligible contract participants") and 4d(a)(1) ("FCM Registration"). To settle the charges, the respondents agreed to (i) SEC and CFTC cease-and-desist orders and (ii) $150,000 in civil monetary penalties for each action.
Commentary
Although the result of these cases is not especially significant (in each case, the allegations suggest clear misconduct and at least some violations of law), the legal analysis is interesting in a few ways, which are mostly unrelated to the use of Bitcoin in the relevant transactions.
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The products offered appear to have effectively been "fully-paid" swaps. That is, the customers posted as "collateral" Bitcoin in an amount equal to the notional of the "swap." However, the Orders do not suggest the customers had any rights as to the assets underlying the transactions (e.g., to acquire or vote them) and the transactions were always intended to be "cash" (Bitcoin) settled.
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The CFTC charged the firms with acting as unregistered futures commission merchants ("FCMs") even though the transactions seem to have solely been uncleared swaps. This suggests a fairly expansive reading of the "futures commission merchant" definition and, if taken literally, would suggest every de minimis swap dealer that collects collateral from its counterparty is acting as an unregistered FCM.
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Though it is not made explicit, the Orders suggest a somewhat expansive extraterritorial view of jurisdiction, at least as to the relevant violations. Each of the SEC and the CFTC emphasize that, even as to the transactions between the non-U.S. firm and non-U.S. customers, U.S.-based employees remained involved in effecting the transactions (even though the counterparty risk was at the Philippines-based firm for those transactions).
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In some ways, it is not surprising and perhaps appropriate that the SEC and the CFTC would assert broad jurisdiction in the case of transactions with retail customers. This case comes at a time when the agencies have been considering how and if U.S. rules should apply to swaps and security-based swaps between two non-U.S. (institutional) persons that are "arranged, negotiated or executed" ("ANE") by U.S. personnel. (The CFTC is scheduled to hold an open meeting on July 23 to consider a proposal that - in contrast to the SEC practice - would largely exclude these ANE transactions from most swaps regulatory requirements.)