CFTC and SEC Charge Foreign Trading Platform Transacting in Security-Based Swaps and Commodity Futures with U.S. Investors

November 08, 2019

Michael Spafford, Joyce Sophia Xu & Daren F. Stanaway

The Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”) have joined forces to charge a Switzerland-based trading platform with various violations of federal securities and commodities laws. The charges stem from the trading platform’s offers of securities-based swaps targeted at U.S. investors, its sales of securities-based swaps to U.S. investors, and its solicitation and acceptance of orders from U.S. customers for the purchase or sale of commodity futures.1 The charges not only illustrate the CFTC’s and SEC’s increasing collaboration, but also illustrate both agencies’ increasing willingness to pursue extraterritorial conduct that targets U.S. customers or otherwise materially impacts U.S. securities and commodities markets.

The SEC Order

The SEC determined that many of the financial instruments offered and sold by the trading platform are “security-based swaps,”2 and thus charged the trading platform with:

violating the Securities Act3 requirement to offer and sell these securities-based swaps to non-eligible contract participants (“Non-ECPs”)4 only on a registered basis;
violating the Exchange Act requirement to effect any purchase or sale of a security-based swap with a Non-ECP only on a national securities exchange; and
failing to register with the SEC as a dealer in connection with its offers and sales of these security-based swaps to U.S. investors.5

With respect to its product offerings, the platform sometimes called its investments “bitcoin Asset Linked Notes” (“bALNs”) and described them as derivative products based on underlying products such as stocks, bonds, and options. bALNs tracked prices of U.S.-listed securities, and investors were able to select the underlying securities and fund the purchase of bALNs using bitcoins.6

The SEC noted in its order that “swaps” and “security-based swaps” generally include “any agreement, contract, or transaction whose value is based on the value of something else (e.g., interest rates, currencies, commodities, or securities) . . . .”7 In finding the bALNs to be security-based swaps, the SEC reasoned that these products “always involved the exchange of the difference in value of an underlying asset from the time at which the accountholder established a position to the time the accountholder terminated the position,” such that accountholders “participated in price movements of an underlying asset without owning it.”8 According to the SEC, where, as here, the underlying asset is a security, this type of product constitutes a security-based swap.

The SEC alleged that the trading platform offered and sold security-based swaps online for a five-year period between 2014 and 2019 and targeted U.S.-based retail investors through a variety of marketing methods, including via promotion of the platform in the United States and giving interviews and participating in podcasts at websites most visited by U.S. residents, but it never registered with the SEC.9 In connection with its know-your-customer (“KYC”) processes, the platform collected customer information, including residency (and therefore knew which of its customers were U.S. residents), but did not utilize this information to block U.S. customers and never required investors to meet certain asset or income thresholds to transact.10 In total, the platform had at least 90 investors who conducted trades in more than 18,000 security-based swaps alone, 24 of whom were U.S. residents that did not qualify as eligible contract participants.11 Although the platform’s website included disclaimers stating that certain U.S. investors were subject to account and trading restrictions, the platform did not enforce these restrictions in practice.12

Based on this conduct, the SEC charged the platform under Section 5(e) of the Securities Act, 15 U.S.C. § 77e(e), which renders it unlawful to offer to sell, offer to buy, or to purchase or sell a security-based swap to any Non-ECP without an effective registration statement; and under Sections 6(1) and 15(a) of the Exchange Act, 15 U.S.C. §§ 78f(l), 78o(a), which render it unlawful to effect a security-based swap with or for a Non-ECP other than on a national securities exchange, and to deal in security-based swap transactions without registering with the SEC.13 The platform entered into a consent settlement with the SEC, agreeing to pay a $100,000 civil penalty and more than $31,000 in disgorgement to the SEC.14

The CFTC Order

The CFTC found that the trading platform acted as a futures commission merchant (“FCM”) by soliciting or accepting orders for commodity futures, and thus violated CEA requirements for all FCMs to register as such with the CFTC.15 More specifically, the CFTC noted that the platform, through its website and electronic trading platform, “solicited or accepted orders for the purchase or sale of commodity futures from U.S. customers,” including 10-Year Treasury Note and E-Micro Gold futures listed on the Chicago Mercantile Exchange (“CME”) Globex trading platform.16 It also “accepted bitcoin to margin customers’ trades” and charged associated fees—thereby accepting money, securities, or property (or extending credit in lieu thereof) to margin, guarantee, or secure trades of U.S. customers, but it never registered with the CFTC.17

Accordingly, the CFTC charged the platform with failure to register as an FCM, in violation of Section 4d(a)(1) of the CEA, 7 U.S.C. § 6d(a)(1).18 The platform entered into a separate consent settlement with the CFTC, agreeing to pay a $100,000 civil penalty and nearly $2,000 in disgorgement to the CFTC.19

Implications for Market Participants

The recent CFTC and SEC settlements with the Switzerland-based trading platform carry a number of implications for other market participants and trading platforms, both domestic and foreign.

First, the settlements indicate that the CFTC and SEC will not shy away from pursuing foreign actors where their conduct and product offerings target or otherwise impact U.S. customers. Both agencies highlighted that the Swiss platform’s products were widely marketed to U.S. customers and easily accessible from the United States online, and that a significant portion of the platform’s customers were U.S. residents. Moreover, the SEC Order suggests that disclaimers restricting U.S. customers from having accounts or making trades, like those that appeared on the platform’s website, have little value if not enforced in practice.20 Accordingly, to the extent a trading platform, swap dealer, or similar entity wishes to restrict its customer base to only non-U.S. customers (thereby potentially avoiding U.S. regulatory registration and other requirements), it must take proactive steps to direct its marketing and advertising campaigns outside the United States and take affirmative steps to block or restrict access by U.S. persons. Reliance on KYC and other processes alone is not enough unless additional steps are taken to identify and restrict use by U.S. persons. Conversely, if an entity wishes to solicit or accept orders for commodity futures (or other similar products) or engage in security-based swap transactions with U.S. customers, it must take steps to ensure compliance with U.S. securities and commodities laws, including applicable SEC and CFTC registration requirements.

With that said, the settlements also raise important questions about the scope of the SEC’s and CFTC’s authority abroad. In the case of the Swiss platform, the agencies premised their claims of jurisdiction upon the platform’s targeting of and marketing to U.S. customers. Absence of U.S. customers does not necessarily render an entity outside the reach of U.S. regulators, however. Indeed, the Securities Act, Exchange Act, and Investment Advisers Act of 1940 afford U.S. courts jurisdiction over suits brought by the SEC alleging violations of those statutes’ antifraud provisions that arise from either “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”21 Accordingly, even conduct occurring wholly outside the United States that does not target U.S. customers still may be subject to U.S. securities laws if it has a “foreseeable substantial effect” within the United States. Under this rubric, it is unlikely that simply offering financial products referencing or indexed or benchmarked to U.S. securities (like those offered by the Swiss platform) to non-U.S. customers, standing alone, would be sufficient to afford the SEC jurisdiction, absent some other factor tying the conduct to the United States. However, if foreign transactions in those products materially impacted or manipulated the prices of the underlying U.S. securities, the conduct may well afford the SEC a basis to exercise its enforcement authority.

The CFTC’s jurisdiction over commodity spot trades and futures, in turn, is largely domestic. The CEA, unlike the federal securities laws, does not include an overarching extraterritoriality provision and generally limits the CFTC’s jurisdiction to “domestic” conduct. Accordingly, the CFTC generally has authority to regulate transactions by U.S. persons, transactions executed on U.S. exchanges, and domestic purchases or sales of commodities and futures contracts in interstate commerce.22 To fall within these parameters, a “domestic transaction” that is not executed on a U.S. exchange must involve either (1) the transfer of title in the United States, or (2) the incurrence of irrevocable liability, such as liability to pay for or deliver the commodity or futures contract, in the United States.23 Accordingly, absent U.S. customers, the CFTC likely would have jurisdiction to pursue conduct related to commodity futures trades made on the Swiss-based platform only if the title transfer or incurrence of irrevocable liability occurred in the United States (which may occur if the platform’s servers were located in the United States, for example).

Second, the settlements with the Swiss trading platform signal increasing cooperation and collaboration between the SEC and CFTC. In announcing the CFTC settlement, for example, CFTC Enforcement Director James McDonald stated: “This case . . . underscores that the Commission will continue working with our law enforcement and regulatory partners to ensure the integrity of our markets.”24 Accordingly, market participants offering or transacting in securities and/or commodity-based products in the United States or with U.S. customers should ensure compliance with applicable securities and commodities laws, including with respect to registration requirements.

Finally, both settlements acknowledge that the civil penalties assessed reflect substantial reductions in light of the platform’s cooperation in the investigation and remedial actions, including repayment of trading losses incurred by U.S. investors.25 Indeed, the platform paid a cumulative total of less than $240,000 combined to the SEC and CFTC, including disgorgement. This underscores that cooperating with U.S. regulators and undertaking proactive, voluntary remedial action may help to mitigate otherwise potentially large civil penalties.

1 Press Release, SEC, SEC Charges International Security-Based Swaps Dealer That Targeted U.S. Investors, Release No. 2019-226 (Oct. 31, 2019), https://www.sec.gov/news/press-release/2019-226 (hereinafter “SEC Press Release”); In re XBT Corp. Sarl, No. 3-19,592, Order Instituting Cease-and-Desist Proceedings, Securities Act Release No. 10,723; Exchange Act Release No. 87,428 (Oct. 31, 2019), https://www.sec.gov/litigation/admin/2019/33-10723.pdf (hereinafter “SEC Order”); Press Release, CFTC, CFTC Charges Foreign Trading Platform for Failing to Register with the CFTC, Release No. 8068-19 (Oct. 31, 2019), https://www.cftc.gov/PressRoom/PressReleases/8068-19 (hereinafter “CFTC Press Release”); In re XBT Corp. Sarl, Order Instituting Proceedings, CFTC Docket No. 20-04 (Oct. 31, 2019), available for download at https://www.cftc.gov/PressRoom/PressReleases/8068-19 (hereinafter “CFTC Order”).

2 SEC Order ¶ 1. The Securities Exchange Act of 1934 (“Exchange Act”) defines a “security-based swap” to include any agreement, contract, or transaction that is a “swap” (as defined under the Commodity Exchange Act (“CEA”)) and is based on (1) an index that is a narrow-based security index; (2) a single security or loan; or (3) the occurrence, nonoccurrence, or extent of an occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer. Id. ¶ 22 (citing 15 U.S.C. § 78c(a)(68)).

3 Securities Act of 1933 (“Securities Act”).

4 Eligible contract participants include various categories of persons and monetary thresholds; individuals need at least $5 million, and often $10 million, invested on a discretionary basis to qualify as eligible contract participants. SEC Order ¶ 23 (citing 7 U.S.C. § 1a(18)).

5 Id. ¶ 6.

6 Id. ¶¶ 2, 12.

7 Id. ¶ 3.

8 Id. ¶ 1.

9 Id. ¶¶ 1-2, 17.

10 Id. ¶ 11.

11 Id. ¶ 18.

12 Id. ¶ 17.

13 Id. ¶¶ 6, 22-27.

14 See id. at 7.

15 CFTC Order at 2-3. The CEA defines an FCM in relevant part as an individual, association, partnership, corporation, or trust that is engaged in soliciting or accepting orders for the purchase or sale of a commodity for future delivery and in or in connection with soliciting or accepting such orders accepting money, securities, or property (or extending credit in lieu thereof) to margin, guarantee, or secure any resulting trades. Id. at 3 (citing 7 U.S.C. § 1a(28)(A)). The CFTC recently brought similar charges against a Marshall Islands cryptocurrency platform and its Austria-based CEO for conducting business in the United States (by soliciting or accepting orders from Non-ECPs for retail commodity transactions—that is, the purchase or sale of commodities on a leveraged or financed basis that do not result in actual delivery) without properly registering as an FCM, and with related failures to properly supervise under 17 C.F.R. § 166.3 by failing to implement adequate KYC and customer identification program (“CIP”) requirements. See Complaint, CFTC v. 1pool Ltd. et al., No. 1:18-cv-02243, Docket No. 1, ¶¶ 2-5, 13-14 (D.D.C. Sept. 27, 2018), https://www.cftc.gov/sites/default/files/2018-09/enf1poolpatrickajeltakecomplaint092718.pdf.

16 CFTC Order at 2.

17 Id. at 2-3.

18 Id. at 3.

19 Id. at 5-6.

20See SEC Order ¶ 17.

21 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 929P(b)(1)-(3), 124 Stat. 1376, 1862-65 (2010).

22 See, e.g., In re LIBOR, 935 F. Supp. 2d 666, 696 (S.D.N.Y. 2013) (“a claim is within the CEA’s domestic application if it involves (1) commodities in interstate commerce or (2) futures contracts traded on domestic exchanges”).

23 Loginovskaya v. Batratchenko, 764 F.3d 266, 273-74 (2d Cir. 2014).

24 CFTC Press Release.

25 See SEC Order ¶ 21; SEC Press Release; CFTC Order at 2 (“Respondent’s cooperation is reflected in the form of a substantially reduced civil monetary penalty.”).

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