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Bitcoin Market Poised for CFTC Insider Trading Scrutiny

Jan. 22, 2018, 3:41 PM

Federal regulators looking for a way to target suspicious cryptocurrency trading may turn to a little-used insider trading regulation put in place after the 2010 Dodd-Frank Act.

The Commodity Futures Trading Commission, which has been one of the most proactive federal regulators in allowing the crypto market to flourish, has the authority to regulate insider trading on spot markets, when commodities are traded for immediate delivery rather than future delivery.

The CFTC has only twice used the rule it adopted in 2011 that bars commodities trading based on nonpublic information secured through deception or fraud, or in violation of a duty to keep information confidential.

The rules could be an attractive tool as federal scrutiny of crypto markets grows.

“Insider trading is something they care deeply about from a market integrity standpoint, so from that perspective, they’re likely to look at it,” Annette Nazareth, a former Democratic Securities and Exchange Commission member and current partner at Davis Polk & Wardwell LLP in Washington, told Bloomberg Law.

Allegations of potential insider trading related to events involving one of the most reputable cryptocurrency exchanges — Coinbase — arose last month after the firm announced it would add to its exchange Bitcoin Cash, an offshoot of Bitcoin created in August.

The price of Bitcoin Cash, already traded on other exchanges, began rising a day before Coinbase’s announcement, and then ticked up significantly just hours before the public announcement.

A Coinbase representative declined to comment to Bloomberg Law, pointing to an earlier statement on its internal investigation. Coinbase CEO Brian Armstrong said in the statement the company prohibits employees from trading on nonpublic information, and anyone found doing so would be terminated and possibly face legal action.

Securities lawyers told Bloomberg Law the events at Coinbase likely drew the attention of Washington regulators.

“I do think they’re going to be enticed by this, and I would think that they are actively engaging Coinbase on the matter,” said former Republican SEC commissioner Paul Atkins, CEO of financial consulting firm Patomak Global Partners LLC in Washington.

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Insider Trading Enforcement

The CFTC’s regulatory authority over commodities traded on spot markets is more limited than it is over derivatives contracts on commodities. The commission’s anti-fraud and anti-manipulation enforcement authorities likely are the only powers the agency could use to bring cases involving trading in Bitcoin and likely other virtual currencies, Jai Massari, a Davis Polk partner in Washington, told Bloomberg Law.

The CFTC in 2011 used its power under Dodd-Frank to adopt Rule 180.1, an anti-manipulation regulation the agency said it modeled on the SEC’s insider trading enforcement authority.

The SEC has made frequent use of its insider trading enforcement authority, bringing 41 actions in fiscal 2017 alone. The cases often involve allegations of buying or selling stocks based on confidential merger plans, unreleased company earnings reports, or other inside information, but haven’t included claims of insider trading related to cryptocurrency.

The CFTC brought its two sole insider trading cases against Florida men who allegedly traded on confidential oil futures information in breach of their duties to their employers. Jon Ruggles reached a $5.25 million settlement with the CFTC in 2016, while Arya Motazedi agreed to pay the agency more than $300,000 to resolve his case in 2015.

The SEC and CFTC have both asserted jurisdiction over virtual currency, giving either agency a chance at bringing the first insider trading case in that area.

The CFTC might make the first move since the agency “is a bit ahead of other U.S. regulators in terms of letting the markets develop,” Massari said.

Jurisdictional Lines

The CFTC has determined Bitcoin and similar virtual currencies are commodities, allowing the commission to stake its claim over fraud and manipulation involving the coins. The SEC, however, may have purview over cryptocurrencies companies issue for initial coin offerings and other fundraising if the coins function like stocks in initial public offerings and similar sales, according to the agency.

Chairmen Jay Clayton of the SEC and J. Christopher Giancarlo of the CFTC repeatedly have warned investors about risks involving cryptocurrency. Bad actors may use virtual currency to conduct Ponzi and pump-and-dump schemes, as well as insider trading, Giancarlo said in early January.

“Undoubtedly, virtual currency and virtual currency derivatives present both significant opportunities and challenges,” he said in a statement at the time. “As a federal market regulator, the CFTC is cognizant of the considerable risks of virtual currencies like Bitcoin.”

The CFTC will hold public meetings exploring cryptocurrency Jan. 23 and 31. Giancarlo and Clayton also will testify at a Senate Banking Committee hearing on their commissions’ oversight of virtual currencies Feb. 6.

CFTC and SEC representatives declined to comment for this story.

Small News Moving Markets

An announcement about a new cryptocurrency trading on an exchange shouldn’t be a major event in a normal market, Peter Van Valkenburgh, an attorney and director of research at Coin Center, a nonprofit cryptocurrency think tank in Washington, told Bloomberg Law.

But even a single new exchange listing is a huge event in the volatile world of Bitcoin trading, where commodity prices can slide 20 percent in a matter of hours from a peak of $19,000. The public can easily impute fraud or ill-intent to any price fluctuation occurring around the listing where there may be none.

“People are grasping for the kind of information that will allow them to earn a massive return like they saw some friend of theirs make when they invested in Bitcoin three years ago, and that’s not healthy,” Van Valkenburgh said.

To contact the reporters on this story: Lydia Beyoud in Washington; Andrew Ramonas in Washington

To contact the editor responsible for this story: Michael Ferullo