Federal Court Confirms CFTC’s Authority Over Cryptocurrencies

Federal Court Confirms CFTC’s Authority Over Cryptocurrencies

The Commodity Futures Trading Commission (CFTC) is authorized to regulate cryptocurrencies, according to a New York federal judge. In a recent decision, U.S. District Judge Jack Weinstein of the U.S. District Court for the Eastern District of New York ruled that virtual currencies are commodities subject to oversight by the CFTC.

CFTC Guidance on Cryptocurrencies

In 2015, the CFTC first found that Bitcoin and other virtual currencies are properly defined as commodities under the Commodity Exchange Act (CEA). As detailed in greater detail in prior articles, the definition of “commodity” in the CEA is broad. It encompasses a physical commodity, such as an agricultural product (e.g., wheat, cotton) or natural resource (e.g., gold, oil), as well as a currency or interest rate. The CEA definition of “commodity” also includes “all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.”

Accordingly, the CFTC has oversight over futures, options, and swaps. It also regulates commodity derivatives contracts that are based on underlying commodities. While its regulatory oversight authority over commodity cash markets is limited, the CFTC maintains general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity in interstate commerce.

In this case, the CFTC relied on its authority under the CEA to bring an enforcement action against Patrick K. McDonnell and his company, CabbageTech, Corp. (doing business as Coin Drop Markets). The suit alleged that the defendants “operated a deceptive and fraudulent virtual currency scheme . . . for purported virtual currency trading advice” and “for virtual currency purchases and trading . . . and simply misappropriated [investor] funds.” In defending the suit, the defendants challenged the CFTC’s regulatory authority over virtual currencies.

Court Decision Ratifying CFTC Oversight

Judge Weinstein agreed with the CFTC position that “virtual currencies can be regulated by the CFTC as a commodity.” He further held that “virtual currencies are ‘goods’ exchanged in a market for a uniform quality and value… They fall well within the common definition of ‘commodity.'”

In reaching his decision, Judge Weinstein acknowledged that until Congress acts to regulate virtual currency, there are several potential regulatory schemes available. They include: no regulation at all; partial regulation by state and federal criminal prosecutions of “Ponzi-like schemes” or by private litigation; regulation by the CFTC; regulation by the Securities and Exchange Commission (SEC) as securities; regulation by the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury as money transmission; regulation by the Internal Revenue Service (IRS) as taxable property; regulation by private exchanges and operators to police themselves; state regulations (i.e. regulations proposed by the New York State Department of Financial Services; or a combination of these regulatory approaches.

Judge Weinstein addressed whether virtual currency may be regulated by the CFTC as a commodity. He answered in the affirmative, agreeing that “[a] ‘commodity’ encompasses virtual currency both in economic function and in the language of the [Commodity Exchange Act].” He also acknowledged that other agencies may also regulate cryptocurrencies. “Until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealing in virtual currency,” Judge Weinstein wrote.

Judge Weinstein also considered whether the amendments to the CEA under the Dodd-Frank Act permit the CFTC to exercise its jurisdiction over fraud that does not directly involve the sale of futures or derivative contracts. He agreed with the CFTC that “where a futures market exists for a good, service, right, or interest, it may be regulated by CFTC, as a commodity, without regard to whether the dispute involves futures contracts.” In support, the court cited 17 C.F.R. § 180.1, which prohibits “any person, directly or indirectly, in connection with any . . . contract of sale of any commodity in interstate commerce” from using a “manipulative device, scheme, or artifice to defraud,” or making “any untrue or misleading statement of a material fact.”

In so ruling, Judge Weinstein confirmed that the CFTC may exercise regulatory oversight over cryptocurrencies traded as futures and derivatives, as well as spot markets underlying those derivative markets. He also noted that the CFTC has recognized that it “does not have regulatory authority over simple quick cash or spot transactions that do not involve fraud or manipulation.”

Key Takeaway for Businesses and Investors

The court’s decision confirms the CFTC’s jurisdiction over cryptocurrencies. At the same time, it also highlights the need for comprehensive federal legislation to more fully address the oversight of virtual currency markets, products, and businesses.

While the regulatory landscape governing cryptocurrencies continues to solidify, a number of legal and regulatory questions remain unanswered. We encourage businesses and investors to consult with an experienced business attorney before engaging in transactions involving virtual currencies. We will also continue to post legal updates on our website, so please check back regularly.

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, at 201-806-3364.