The U.S. District Court for the District of Massachusetts has held that all virtual currencies are commodities that are subject to the Commodity Futures Trading Commission anti-fraud jurisdiction. In deciding on a motion to dismiss in favor of the CFTC in its case against My Big Coin on September 26, the court concluded that all virtual currencies are commodities regardless of whether a futures contract is traded on the specific virtual currency in question, and that the CFTC has jurisdiction to bring an enforcement case regardless of whether alleged fraud with regard to the virtual currency involved market manipulation. This decision is another victory for the CFTC — following its win earlier in 2018 on a motion to dismiss in CFTC v. McDonnell, et al. — in its efforts to police the spot cryptocurrency markets.1
Overview of CFTC v. My Big Coin Pay, Inc. et al.
In its January 2018 complaint, the CFTC alleged that the defendants operated a virtual currency scheme that they made appear to be a “fully-functioning” virtual currency. Defendants claimed that their product, My Big Coin, was backed by gold, accepted for payment anywhere MasterCard is accepted and that it traded on several currency exchanges when the CFTC alleged that in fact none of these statements were true. Those who invested in the scheme could review their accounts but could not trade My Big Coin or withdraw funds from their accounts. Although the cryptocurrency was not being traded on any exchange, the CFTC alleged that the defendants changed the price of My Big Coin arbitrarily to mimic exchange price fluctuations and reported the changes to customers. The alleged scheme, which ran from January 2014 to approximately June 2017, brought in approximately $6 million from at least 28 customers. The CFTC alleged that My Big Coin was a Ponzi scheme.
Whether My Big Coin is “Commodity”
The CFTC regulates the markets for and trading activity in commodity interests — derivative contracts such as futures, options and swaps written with commodities as the reference asset, but the CFTC does not generally regulate the spot or cash market in the underlying commodities.2 So for example an ETF that trades gold futures is a commodity pool regulated by the CFTC, but an ETF that holds physical gold and no futures, options or swaps written on the price of gold is not a commodity pool and is not regulated as such by the CFTC. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 expanded the CFTC’s jurisdiction to bring actions for conduct related to “any manipulative or deceptive device or contrivance…in connection with any… contract of sale of any commodity in interstate commerce.”3 As a result, the CFTC has the power to bring an enforcement action related to spot or cash commodities, but the question with regard to virtual currencies is whether they are commodities as defined in the Commodity Exchange Act (CEA). Under CEA Section 1a(9), a “commodity” is defined by enumerating multiple items including wheat, cotton, soybean oil, livestock and frozen concentrated orange juice, etc. and as “all other goods and articles…and all services, rights, and interests…in which contracts for future delivery are presently or in the future dealt in.” In the defendants’ motion to dismiss, they argued that My Big Coin could not be a “commodity” because there are no futures contracts available to be traded on My Big Coin.
The court determined that because there is presently a futures contract available on at least one type of virtual currency Bitcoin,4 that My Big Coin, as a virtual currency, is a commodity. In coming to this conclusion, the court noted that the CEA defines commodities in broad categories and does not define commodities specifically as to “type, grade, quality, brand, producer, manufacturer, or form,” so that, for example, all livestock are commodities without the CEA needing to specify species of livestock.5 As a result, when taking into consideration Congress’ intent that the CFTC regulate the commodity futures trading industry and police fraud and manipulation in these markets, the court determined that this reading of the definition of “commodity” to include virtual currencies even where there is no futures contract traded on the specific currency is appropriate.
Whether the CFTC Can Bring an Action that Does Not Involve Market Manipulation
In the defendants’ motion to dismiss, they had argued that even if My Big Coin were a commodity, the CFTC’s power to bring an action for fraud against them would only be possible if the CFTC could allege some sort of market manipulation related to the defendants’ actions.
However, the court was unpersuaded, noting that the law states that any “manipulative or deceptive device or contrivance” in connection with the sale of a commodity is banned and that the implementing regulation also serves to give the CFTC power to prosecute fraud even where there has been no market manipulation.6
How Dechert Can Assist
As the CFTC exercises jurisdiction over virtual currency-related products and services, companies operating in that space will need to be aware of the restrictions stemming from the CEA. The law’s restrictions extend to price manipulation — including “pump-and-dump schemes” — in virtual currency, pre-arranged and wash trading in exchange-traded swap or futures contracts, futures and option contracts and swaps on virtual currencies traded on a platform not registered with the CFTC. The law also appears to extend to fraud related to virtual currencies where there is no market manipulation readily observable, such as fraudulent misrepresentations.
The increasing use of virtual currencies and other digital assets has given rise to complex legal issues relating to regulatory status (including requirements to register as broker-dealers, commodity pool operators, commodity trading advisors, investment advisers, investment companies, securities exchanges and money service businesses), compliance (including valuation, custody and reporting), corporate law (such as maintain shareholder records), securities transactions (including initial coin offerings and M&A transactions), fund formation, the launch of ETFs and derivatives, venture capital, taxation, anti-money laundering, litigation and regulatory enforcement.
Dechert offers sophisticated and knowledgeable legal counsel to clients navigating this rapidly evolving space. At the heart of Dechert’s virtual currency and blockchain practice is a deep understanding of the technologies that drive blockchain and related developments in distributive computing networks. In addition, Dechert is distinctive among leading law firms in this area by bridging the financial service regulation and new financial technology to find solutions for our clients.
1) See Dechert OnPoint, Federal Court Ruling Recognizes CFTC Jurisdiction over Cryptocurrencies as Commodities
2) The CFTC shares regulatory jurisdiction with the Securities and Exchange Commission over certain derivatives such as security futures (futures contracts written with a single security or narrow-based security index as the reference asset).
3) 7 U.S.C. § 9(1); 17 C.F.R. §180.1(a).
4) See Dechert OnPoint, Bitcoin Futures Trading Commences; Implications for Funds and Registered CPOs and CTAs.
5) The CFTC’s primary arguments for the reason My Big Coin is a commodity were actually more expansive. The CFTC argued that My Big Coins and other similar virtual currencies are intangible goods or articles and are therefore commodities. The CFTC also argued based on syntax, punctuation and grammar that the clause of the commodity definition “in which contracts for future delivery are presently or in the future dealt in” only modifies the phrase “all services, rights, and interests” so that any other goods and articles are commodities regardless of whether a futures contract is currently or in the future available for trading with the good or article as the reference asset. Because My Big Coin fall into the category of items that are not required to have a futures contract to be a commodity, they are commodities regardless of whether a futures contract is currently or in the future traded on them. In deciding on the motion to dismiss, the court declined to adopt this broader reading of the definition of commodity.
6) This conclusion was in contrast to a federal court decision in California in May 2018 involving a commodity that is not a virtual currency where the court found that the CFTC’s CEA Section 6(c)(1) authority is limited to fraud-based market manipulation (See CFTC v. Monex Credit Co. (C.D. Cal. May 1, 2018)). But the conclusion was in accord with two other recent federal court decisions, McDonnell (discussed herein) and the other involving a precious metals telemarketing firm (See CFTC v. Hunter Wise Commodities, LLC (S.D. Fla. 2014)).