CFTC Fines Crypto Exchange That Offered Margin Trading For Failing To Register As FCM, Prompting Calls For Further Rulemaking From One Commissioner
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  • CFTC Fines Crypto Exchange That Offered Margin Trading For Failing To Register As FCM, Prompting Calls For Further Rulemaking From One Commissioner
     

    10/06/2021
    On September 28, 2021, the Commodity Futures Trading Commission (CFTC) entered an order that imposed a $1.25 million fine on Payward Ventures Inc., which does business as digital asset exchange Kraken, for allegedly failing to register as a futures commission merchant (FCM) and for offering certain margin trading services in violation of Sections 4(a) and 4d of the Commodity Exchange Act (CEA).  Although the decision did not purport to break new legal ground, one CFTC Commissioner, Dawn Stump, noted that the decision “is informed by” the CFTC’s Final Interpretive Guidance on retail commodity transactions involving certain digital assets issued in 2020, and issued a concurring statement calling upon the CFTC to issue rulemaking to clarify and codify that guidance, which is increasingly important in the cryptocurrency space.

    Kraken is a digital asset company whose primary business is the operation of an online digital asset exchange.  The exchange enables customers to engage in retail commodity transactions involving digital assets, such as Bitcoin and other crypto currencies.  As part of this business, Kraken also provides margin extensions to some of its customers, which they can use to buy or sell digital assets on a leveraged basis.  During the relevant period in the CFTC’s order, margin trading was available to any U.S. person who Kraken approved for a user account.

    The CFTC alleged that in providing the margin, Kraken entered into contracts with the margin customers that would remain open until either (1) the customer submitted a closing trade, (2) the customer repaid the margin, or (3) the customer held her trading position for longer than 28 days, in which case Kraken was entitled to force the customer to liquidate her position.  Crucially, the CFTC claimed in its order that “[i]n engaging in these transactions with customers, Kraken never transferred possession and control of the entire quantity of the assets purchased using margin.”

    Broadly, Section 4(a) of the CEA makes it unlawful for a business to deal in a commodity futures contract unless the transaction is made on, or subject to the rules of, a board of trade that has been designated or registered by the CFTC as a contract market for the specific commodity.  And Section 2(c)(2)(D) provides that Section 4(a) applies to any transaction in any commodity that is entered into with, or offered to, a non-eligible contract party (ECP) on a margined or leveraged basis and that does not result in actual delivery of the commodity within 28 days.  Further, Section 1a(28) says that any business that engages in such transactions is a FCM, and Section 4d(a)(1) requires FCMs to register with the CFTC.

    Here, the CFTC alleged that because Kraken never transferred the entire quantity of the assets purchased on margin to the customers under these margin contracts, Kraken’s margin services involved commodity futures contracts offered to non-ECPs.  Thus, Kraken’s margin services allegedly violated Section 4(a) because the margin contract transactions were not made on, or subject to the rules of, a board of trade that had been designated by, or registered with, the CFTC, and that  Kraken was a FCM that had failed to register with the CFTC in violation of Section 4d(a)(1).

    The fine levied against Kraken represents the first time the CFTC has applied its FCM rules to a retail commodity exchange.  And yet, the CFTC’s action does not purport to break new legal ground, and instead seems to leverage prior guidance the CFTC had issued regarding how such rules may apply in the cryptocurrency space.  Indeed, Commissioner Stump noted:
    Although it is not mentioned in the settlement Order, the Commission’s finding that Kraken engaged in prohibited retail commodity transactions is informed by its Final Interpretive Guidance on retail commodity transactions involving certain digital assets issued in 2020 (the “Guidance”).  Kraken’s conduct as described in the Order aligns with some of the illustrative examples discussed in the Guidance, and it can be no coincidence that the Order defines the “Relevant Period” as beginning in June 2020 – three months after then-Chairman Tarbert announced in March 2020 ‘that for a period of 90 days the CFTC will forbear from initiating enforcement actions addressing aspects of [the Guidance] that were not plainly evident from prior CFTC guidance, enforcement actions, and case law.”

    She went on to state her view that, “as the Guidance becomes increasingly relevant to the Commission’s enforcement program, I believe it is incumbent upon the Commission to undertake a rulemaking proceeding to supersede the Guidance by adopting binding and enforceable rules that will provide certainty to the marketplace and a shared understanding of the ‘rules of the road.’”

    Pending any further rulemaking, the CFTC’s latest action is simply a reminder that its existing rules can apply to any number of scenarios in the rapidly developing fintech space generally, and crypto currency trading specifically, and that the CFTC (and other regulators) will particularly apply scrutiny whenever retail customers are impacted.

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