The CFTC’s Not-So-Hidden Message: Traders Beware

Bitcoin law experts Brian Klein and Geoffrey Aronow explore recent rulings by the US CFTC and how they affect bitcoin traders across the world.

AccessTimeIconOct 3, 2015 at 8:50 a.m. UTC
Updated Sep 11, 2021 at 11:54 a.m. UTC
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The US Commodity Futures Trading Commission (CFTC) recently announced settlements with two digital currency businesses, which, at first glance, may appear to impact only businesses, not individual traders. But the implications for anyone trading digital currencies, like bitcoins, regardless of where they live and trade are significant and need to be carefully considered.

The CFTC can be expected to bring future enforcement actions not just against businesses operating in the US, regardless of whether they have a physical presence there, but also against individual traders all around the world. This is because the CFTC asserts jurisdiction, at a minimum, over any transaction, wherever it may occur and whoever may be trading, that has a connection to conduct in the US or an effect on commerce in the US.

As a reminder, on 17th September 2015, the CFTC announced a settlement with Coinflip for marketing bitcoin derivatives without being properly registered with the CFTC. A week later, on 24th September 24, the agency announced a settlement of charges against TeraExchange, a CFTC-registered Swaps Execution Facility (SEF), for allowing a digital currency swap trade that was both a “wash trade” and a “prearranged trade,” in violation of US law and regulations.

Although in neither case were fines assessed or serious sanctions handed down, the very fact that the CFTC brought the cases without seeking such penalties and publicly announced them close in time demonstrates that it wanted to give “fair warning” to market participants that, in the future, they had better adhere to CFTC rules and regulations, or else.

Traders not immune

The fact that the CFTC acted against the trading platforms in these cases does not mean that traders themselves are immune from risk. Far from it. There are a number of US regulatory requirements that anyone trading digital currency swaps or other derivatives – and even, in some cases, trading any digital currency products – need to be sensitive to and have in mind as they trade such products. This is true even if the trader does not live in the US because of the long reach of US law.

Here are some of the key land mines:

  1. While simply trading digital currency (like bitcoins) on an exchange does not require CFTC registration, if you give advice to others or otherwise involve yourself in the process of placing the trades of others, you may need to register with the CFTC.
  2. A digital currency contract that is determined to be a derivative (eg a future or a swap) or an option must be traded on a platform or otherwise in a manner consistent with CFTC requirements or you may be violating the law simply for engaging in the transaction.
  3. As highlighted by the TeraExchange case, US regulations prohibit a transaction that can be characterized as a “wash trade”, an “accommodation trade”, a “fictitious sale”, or a trade that “is used to cause any price to be reported, registered, or recorded that is not a true or bona fide price”. These provisions have been broadly applied to any situation where the CFTC believes the process by which a transaction occurs was not fair, open and competitive (unless otherwise provided for under its rules). And they create potential liability for the traders, not just the exchange.
  4. For trades done on a CFTC registered platform, such as a SEF like TeraExchange or a contract market, there are specific prohibitions against (1) violating bids or offers, (2) intentional or reckless disregard for the orderly execution of transactions during a closing period, or (3) “spoofing”, which is defined in the statute as “bidding or offering with the intent to cancel the bid or offer before execution”. Spoofing is an area of particular CFTC attention recently.
  5. There are prohibitions related to the theft or conversion and use of nonpublic information from the US government.
  6. CFTC regulations broadly prohibit fraud in connection with any transaction under its jurisdiction. Technically, the language of one of the provisions reaches any cash commodity transaction in interstate commerce, although it is unlikely the CFTC wants to become the general overseer of fraud in all commercial marketplaces. But it does mean the CFTC may be able to exercise its discretion to bring a case if it otherwise becomes focused on a problem in the marketplace. Moreover, the relevant statute specifically prohibits a person from entering into a swap transaction “knowing, or acting in reckless disregard for the fact that its counterparty will use the swap as part of a ... fraud against a third party". The CFTC does not generally have to show actual intent to defraud, but can bring a case based on reckless conduct.
  7. The CFTC has broad authority to police for manipulation. Here, the CFTC will look at manipulation not only directly in the derivatives market, but also in the “cash” market where it believes there is the potential for a price distortion effect on a related derivatives market. The CFTC does not need to prove actual intent to manipulate, but simply recklessness. And it has jurisdiction to seek serious sanctions, including fines of $1m per violation, and for attempted manipulation, which requires only evidence of the necessary state of mind (intent or recklessness) and an act that it can say was taken in furtherance of the manipulation.

Potential charges

In most cases under the CFTC statutes, rules, and regulations, persons can be civilly charged with being aiders or abettors, and can face principal-agent liability for any of the violations of law that the CFTC oversees. And, with regard to fraud and manipulation, egregious cases may well draw scrutiny from criminal prosecutors.

Besides substantial civil monetary penalties, the CFTC can seek cease-and-desist orders or injunctions against further misconduct, disgorgement of proceeds and/or restitution to injured parties, and registration and trading bans and suspensions.

The latter is worth highlighting because, unlike the SEC in the securities markets, the CFTC can actually suspend or ban people from trading in derivatives markets, whether or not the person is a registrant.

The bottom line is that digital currency traders, regardless of where they live and trade, need to proceed with eyes wide open to the regulatory structure that the CFTC has now expressly warned will be applied to trading in digital currency markets.

Failure to pay attention to these trading limitations can result not just in actions against the platforms on which the trading occurs, but against the traders themselves. Further, the response may not just be civil litigation but also prosecution by the criminal authorities. Traders everywhere need to beware.

Caution image via Shutterstock


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