Paul Architzel is Senior Counsel, Matt Kulkin is Partner and Chair of the Futures and Derivatives Practice, Matt Beville is Special Counsel, Daniel Martin is Counsel, and Reid Carroll, Eliza Gonzalez, Blake Sweat, and Ayana Dow are Associates in the WilmerHale Futures and Derivatives Practice Group. Previously, Mr. Architzel served as Chief Counsel of the (now) CFTC Division of Market Oversight, Mr. Kulkin served as Director of the CFTC (now) Market Participants Division.
I. Overview
The year 2022 was a historic year for the Commodity Futures Trading Commission ("CFTC" or the "Commission"). Just four days into the new year, on January 4, 2022, Rostin Behnam was sworn in as the CFTC's 15th Chairman. Three months later, on March 28, 2022, the U.S. Senate approved four new Commissioners – Christy Goldsmith Romero, Kristin Johnson, Summer Mersinger and Caroline Pham – by unanimous consent, and each Commissioner was sworn into her new role within a few weeks. In addition, following the confirmation of Chairman Behnam, the CFTC's executive leadership team was reconstituted, largely from experienced CFTC career staff, providing for continuity in leadership and preservation of institutional memory, but perhaps at the expense of fresh perspective.1
As a result of this transition period, much of the activity at the CFTC in 2022 focused on the integration and establishment of the new leadership of the agency. Once in office, Commissioners made staff appointments, took up sponsorship of Advisory Committees, and went on "listening tours" to meet with constituents and registrants in the United States and around the world.
Chairman Behnam, just weeks after taking office, gave a preview of his agenda at an industry conference.2 He identified, among other issues, cash market oversight, the rise of retail market participants, global regulatory coordination, climate-related financial risk, and the collection, use, analysis, and protection of data as priority topics. Perhaps recognizing that market events could impose on his plans, he presented his agenda as "subject to change."
The past year saw new developments in digital asset markets, efforts to expand the types of derivatives products regulated by the CFTC, including developments in both the event contract space and the retail commodity/precious metals space. Record-breaking penalties and fines were issued from an aggressive enforcement effort, with novel theories established in new cases that covered a broader set of cases than seen before. At the same time, international regulatory bodies deliberated on how to prevent or mitigate the next financial crisis and ensure global coordination on new laws and regulations, as well as cross-border oversight of global financial firms. The CFTC explored intermediation and the role of brokers, as well as potential changes to global market structures. As Chairman Behnam described the CFTC's agenda during a March 2022 speech, the agency would move deliberately and "reassess, reevaluate, and reprice"3 its priorities and positions.
II. Crypto-asset and Defi Developments
A completely new asset class is introduced into the financial ecosystem perhaps once in a generation. Equally rare is the introduction of a completely new technology that results in a fundamental change in the manner of doing business. The CFTC successfully addressed both during its formative years, bringing under its regulation a new asset class—financial futures—and successfully navigating the introduction of a then revolutionary technology—computerized trading. The CFTC met the introduction of both creatively, stretching its regulatory framework to incorporate both developments and in doing so, fostering their acceptance and growth. This foundational experience of successfully finding regulatory solutions to market innovation has entered the DNA of the agency, resulting in its flexibility and creativity in applying its regulatory framework to ground-breaking market developments.4
The CFTC's openness to applying the regulatory framework which it administers to innovative developments may not be sufficient, however, to meet all challenges, particularly those that test the boundaries of jurisdiction among federal regulators. For example, the introduction of financial futures resulted in Congress amending the Commodity Exchange Act, 7 U.S.C. §1 et seq. (the "CEA" or "Act") to formalize the role of the Department of Treasury in reviewing new Treasury-related products and passage of the Shad-Johnson Accord to settle the jurisdictional boundary between the CFTC and SEC relating to stock index futures.5
Much of the CFTC's attention during 2022 has been to respond to the challenges presented by the growth of crypto asset trading, a new asset class that often is coupled with new trading technologies. In light of the Commission's limited jurisdiction over spot markets,6 its response to trading of crypto commodities has been mainly through enforcement. Notably, according to the CFTC's annual enforcement report, approximately 20% of the enforcement actions filed in fiscal year 2022 were against crypto-related entities, evidencing the significant amount of resources the Commission is devoting to this topic, a trend that we expect will continue.
A. Crypto-related Enforcement Developments
Although the CFTC does not have regulatory authority over spot markets, it can bring actions challenging allegedly fraudulent or manipulative activities regarding spot commodities in interstate commerce. In 2015, the CFTC determined that Bitcoin and other digital assets are within the definition of "commodity" under Section 1a(9) of the Act.7 It has since found that Ethereum, Litecoin, and at least several stablecoins are also commodities. Relying on this, and other authorities, the CFTC has brought a significant number of enforcement actions regarding alleged misconduct in digital asset markets.8
Although quite active, the Commission's crypto docket has largely matured and its enforcement actions now largely fall into two main categories.
First, the CFTC has brought a number of cases against entities that have allegedly failed to register as designated contract markets ("DCMs")9 or futures commission merchants ("FCMs"),10 including
entities that offered leveraged retail commodity contracts in violation of the prohibition of section 2(c)(2)(D) of the Act. In these matters, the CFTC also often finds that the defendant or respondent failed to comply with other regulations, such as applicable Know-Your-Customer or Bank Secrecy Act requirements.
Second, the CFTC has brought a number of actions involving alleged fraud11 or manipulation involving crypto assets.12 This included allegations of one of the largest Bitcoin fraudulent schemes to date, involving over $1.7 billion in allegedly misappropriated assets.13
In many cases, these categories overlap, but most cases involve familiar fact patterns that are well-within fact patterns consistent with the Commission's established enforcement precedent. However, there were several noteworthy developments in 2022 that signal the CFTC's continued interest in expanding its role in regulating crypto asset markets:
In September 2022, the Commission brought its first-ever enforcement action against a decentralized autonomous organization ("DAO"). In September 2022, the CFTC announced a settled action against bZeroX and two of its founders for developing a digital asset protocol that offered leveraged retail commodity transactions without registering as a DCM or FCM.14 The protocol used smart contracts to allow participants to establish disintermediated leveraged positions across digital asset pairs.15 This decentralized protocol included automated collateral requirements and mechanisms to liquidate positions in the event losses exceeded the value of the posted collateral. Around August 2021, one of the founders announced plans to "future proof" the bZeroX protocol by transferring control from bZeroX to a DAO, which would continue to offer leveraged commodity transactions to retail customers.16 The CFTC found that this plan was intended to evade regulatory requirements by transferring ownership of the protocol from a distinct legal entity to a distributed "community."17
In the settled order, the CFTC found that the virtual currencies traded on the bZx Protocol, which included ETH and DAI, are "commodities" under the CEA, a requisite finding for liability. The CFTC found that the virtual currencies were "retail commodity transactions," which are regulated like derivatives, because they were offered to retail customers on a leveraged basis but were not "actual[ly] deliver[ed]" within 28 days.18 The CFTC found that bZeroX and the individual founders offered illegal leveraged retail commodity transactions without registering as a DCM in violation of Section 4(a) of the CEA and failed to register bZeroX as an FCM in violation of CEA Section 4d(a)(1). The CFTC also found that bZeroX and the founders violated CFTC regulation 42.2 by failing to adopt a Customer Identification Program to implement Know-Your-Customer requirements for bZeroX's FCM activities. This component of the action was straightforward and consistent with the CFTC's prior actions in this space.
However, the CFTC order went further and found that the bZeroX founders were personally liable for the Ooki DAO's ongoing violations through their roles in proposing and voting on DAO governance proposals. Specifically, the order found that the Ooki DAO is an unincorporated association because it is a (1) voluntary group of people, (2) without a charter, (3) formed by mutual consent, (4) promoting a common objective.19 "Once an Ooki Token holder votes his or her Ooki Tokens to affect the outcome of an Ooki DAO governance vote, that person has voluntarily participated in the group formed to promote the common objective of governing the Ooki Protocol and is thus a member of the Ooki DAO unincorporated association."20 The order found that, under principles of partnership law, the bZeroX founders were members of an unincorporated association organized for profit and thus are personally liable for Ooki DAO's violations of the CEA.21
Footnotes
1 The executive leadership team includes: Tanisha Cole Edmonds Clark, Chief Diversity Officer; Clark Hutchison, Director, Division of Clearing and Risk; Gretchen Lowe, Acting Director, Division of Enforcement; Vincent McGonagle, Director, Division of Market Oversight; Amanda Olear, Director, Market Participants Division; Suyash Paliwal, Director, Office of International Affairs; Tamara Roust, Director, Division of Data, and Robert Schwartz, General Counsel.
2 Rostin Behnam, Chairman, Comm. Fut. Trading Comm'n, Keynote Address at the ABA Business Law Section Derivatives & Futures Law Committee Virtual Winter Meeting (Mar. 16, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam19.
3 Rostin Behnam, Chairman, Comm. Fut. Trading Comm'n, Keynote at the FIA Boca 2022 International Futures Industry Conference, Boca Raton, Florida (Mar. 16, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam21.
4 For example, the Commission was one of the first agencies to address digital assets. Starting in 2015, the CFTC began filing cases involving Bitcoin (In re Coinflip, Inc., CFTC No. 15-29, 2015 WL 5535736 (Sept. 17, 2015) and In re TeraExchange LLC, CFTC No. 15-33, 2015 WL 5658082 (Sept. 24, 2015)). 1 The executive leadership team includes: Tanisha Cole Edmonds Clark, Chief Diversity Officer; Clark Hutchison, Director, Division of Clearing and Risk; Gretchen Lowe, Acting Director, Division of Enforcement; Vincent McGonagle, Director, Division of Market Oversight; Amanda Olear, Director, Market Participants Division; Suyash Paliwal, Director, Office of International Affairs; Tamara Roust, Director, Division of Data, and Robert Schwartz, General Counsel.
5 See 7 U.S.C. § 2(c)(1) (the statutory exclusion of certain Treasury-related products was first enacted in 1974); see also Futures Trading Act of 1982, Pub. L. No. 97-444, 96 Stat. 2294 (1983); Act of Oct. 13, 1982, Pub. L. No. 97-303, 96 Stat. 1409.
6 The CFTC has limited jurisdiction over cash (spot) markets by maintaining enforcement authority over interstate commerce involving commodities through general anti-fraud and manipulation provisions.
7 See In re Coinflip, Inc., CFTC No. 15-29, 2015 WL 5535736, at *2 (Sept. 17, 2015), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder091 72015.pdf.
8 Examining Digital Assets: Risks, Regulation, and Innovation: Full Committee Hearing Before S. Comm. on Agric., Nutrition, & Forestry (Feb. 9, 2022), https://www.agriculture.senate.gov/imo/media/doc/Testimony_Behnam_020920225.pdf (testimony of Rostin Behnam, Chairman, CFTC).
9 On October 3, 2022, the CFTC filed a complaint against Adam Todd and four companies he controlled— Digitex LLC, Digitex Limited, Digitex Software Limited, and Blockster Holdings Limited Corporation (together "Digitex Futures")—alleging that he and Digitex Futures operated an unregistered commodity exchange, https://www.cftc.gov/media/7826/enfdigitexcomplaint093022/download.
10 The CFTC also charged that because Digitex Futures met the statutory definition of an FCM, it was required to comply with the applicable provisions of the Bank Secrecy Act, including requirements to implement effective KYC procedures and a customer information program ("CIP"). The CFTC alleged that Digitex Futures did not have effective KYC procedures and did not implement an effective CIP, thus violating 17 C.F.R. § 42.2. CFTC, Statement of Commissioner Kristin N. Johnson Regarding UnregisteredCrypto Futures Platform, Price Manipulation, and Failure to Comply with AML/KYC/CIP Obligations (Oct. 3, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement100322.
11 On May 19, 2022 the CFTC filed a civil enforcement action against Sam Ikkurty, Ravishankar Avadhanam, and Jafia LLC for fraudulently soliciting participation interest in an income fund that invested in digital assets and other instruments. Compl., CFTC v. Ikkurty, No 1:22-cv-02465 (N.D. Il. May 10, 2022), ECF No. 1, https://www.cftc.gov/media/7266/enfsenecacomplaint051022/download. According to the complaint, the defendants solicited more than $44 million from at least 170 individuals to purchase, hold, and trade digital assets, commodities, derivatives, swaps, and commodity futures contracts. However, the defendants allegedly did not invest the pooled funds as represented, instead the funds were transferred to other accounts under defendants' control for their sole benefit. The CFTC seeks restitution for defrauded investors, disgorgement of ill-gotten gains, civil monetary penalties, permanent trading and registration bans, and a permanent injunction.
12 The CFTC's first enforcement action involving a digital asset manipulation scheme was brought on March 5, 2021, when it filed a complaint in the Southern District of New York against John McAfee and his former employee, Jimmy Gale Watson for allegedly engaging in a pump-and-dump scheme in a variety of digital currencies. Compl., CFTC v. McAfee, No. 1:21-cv-01919 (S.D.N.Y. Mar. 5, 2021), ECF No. 1, https://www.cftc.gov/media/5741/enfjohndavidmcafeecomplaint030521%20/download. On July 18, 2022, after McAfee's death, the court entered a Consent Order against Watson that found Watson engaged in price manipulation in violation of Sections 6(c)(3) and 9(a)(2) of the Act and Regulation 180.1, requiring Watson to disgorge $144,736 in ill-gotten gains, and pay a civil monetary penalty of the same amount. Consent Order, CFTC v. McAfee, No. 1:21-cv-01919 (S.D.N.Y. July 14, 2022), ECF No. 38, https://www.cftc.gov/media/7481/enfjimmywatsonconsentorder071422/download. In addition, the Commission in the Digitex case alleged that the respondent attempted to manipulate the price of the Digitex exchange's native currency, DGTX, by engaging in non-economic trading activity on third-party digital asset trading platforms with the intent to artificially inflate the price of DGTX and increase the value of the DGTX. Specifically, the CFTC alleged Todd pumped the price of DGTX by developing a "bot" that purchased and sold DGTX on third-party exchanges but was designed to always buy more than it sold, and by filling large over-the-counter orders to purchase DGTX from third-party exchanges rather than Digitex's reserves, which owned hundreds of millions of DGTX tokens. CFTC Press Release No. 8605-22 (Oct. 3, 2022), https://www.cftc.gov/PressRoom/PressReleases/8605-22.
13 Compl., CFTC v. Mirror Trading Int'l Proprietary Ltd., No. 1:22-cv-00635 (W.D. Tex. June 30, 2022), ECF No. 1, https://www.cftc.gov/media/7426/enfmirrortradingcomplaint063022/download.
14 In re bZeroX, LLC, CFTC No. 22-31, 2022 WL 4597664 (Sept. 22, 2022), https://www.cftc.gov/media/7676/enfbzeroxorder092222/download.
15 2022 WL 4597664, at *2-3.
16 Compl. ¶ 3, CFTC v. Ooki DAO, No 3:22-cv-5416 (N. D. Cal. Sept. 22, 2022), ECF No. 1, https://www.cftc.gov/media/7681/enfookicomplaint092222/download.
17 In re bZeroX, 2022 WL 4597664, at *4.
18 Id. at *1, *6.
19 Id. at *9-10.
20 Id. at *8.
21 Although this case is novel, it is not completely without antecedents. The Act, prior to passage of the Commodity Futures Modernization Act of 2000, defined a "board of trade" as meaning "any exchange or association, whether incorporated or unincorporated, of persons who shall be engaged in the business of buying or selling any commodity."
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