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DEF Comments on FinCEN’s NPRM; Senators Introduce Legislation to Combat Illicit DeFi Activity; SEC v. Binance

DEF Comments on FinCEN’s CVC’s Rule-Making 

What Happened? 

Last Monday, we submitted a comment letter to the Financial Crimes Enforcement Network (FinCEN) in response to their proposed rulemaking, titled “Proposal of Special Measure Regarding Convertible Virtual Currency Mixing, as a Class Of Transactions of Primary Money Laundering Concern.” While we support FinCEN’s goal of creating policy that will prevent illicit activity and support maintaining a safe and secure ecosystem, we believe the proposed rule will, at best, only minimally achieve its stated goals and come at a high cost.

In our comment letter, we argue that there are existing regulatory requirements under the Bank Secrecy Act (BSA) that provide for the collection, retention, and reporting of nearly the same information as described in this proposal. FinCEN and its government partners need only clarify, examine for compliance with, enforce, and potentially update these existing requirements to accomplish the Proposal’s goals. 

Furthermore, the proposed rulemaking in its current written form is arbitrary and capricious. For instance, the definition of convertible virtual currency (CVC) mixers (“any person, group, service, code, tool, or function that facilitates CVC mixing”) is so broad that it captures nearly all cryptocurrency transactions, and the proposal concludes, without elaboration, that the breadth of this definition is “necessary” because of the “nature of CVC mixing.” 

Lastly, we point out the significant deleterious effects the proposed rule would have on U.S. user’s privacy, violating their Fourth Amendment rights, and that it will suppress development of and investment in privacy-enhancing technologies in the United States.

What does this mean?  

The proposal oversteps legal boundaries and arbitrarily impacts legitimate users and businesses in the crypto space. Protecting financial privacy is a right guaranteed by the Fourth Amendment of the U.S. Constitution. Imposing blanket reporting requirements on vaguely-defined activities “due to its nature” raises critical concerns on compliance costs and overextension of government surveillance. Addressing money laundering is a paramount concern, but any measures taken should align with the legal standards established in traditional financial markets, where financial data is not instantly at the disposal of government agencies; it's subject to legal protections that are meant to vindicate the rights of law-abiding citizens. Similar standards of privacy and due process should be expected in crypto-related regulation. 

Senators Introduce Legislation to Combat Illicit DeFi Activity

What happened?

Last Wednesday, Senators Bill Hagerty (R-TN) and Cynthia Lummis (R-WY), members of the Senate Banking Committee, introduced the Preventing Illicit Finance Through Partnership Act of 2024. The bill aims to combat the illicit use of crypto assets by bolstering information-sharing between federal law enforcement agencies and private companies. The pilot program would enable specific federal agencies to exchange information regarding their investigations into illegal activities involving crypto with selected private sector organizations. Additionally, private entities would have a pipeline to alert government agencies about suspicious activity or sanctions evasion. Information-sharing by private entities is voluntary and entities are protected from liability under U.S. or state laws for disclosing information.

In the bill’s announcement, Senator Lummis explained that “There are bad actors in every industry and crypto assets are no exception but make no mistake – crypto itself is not the problem.” Senator Hagerty added that the bill “would help law enforcement agencies leverage their existing authorities to better identify violations without stifling innovation.” The Senators are hopeful that the program, if instituted, would crack down on fraudulent schemes involving crypto and increase consumer confidence. 

What does this mean?

As Senator Hagerty remarked, the bill illustrates an effort from Congress to combat illicit activity using existing authorities in a way that does not stifle innovation. We welcome this bill as a positive step forward and thank the senators for their efforts. We look forward to seeing this bill’s progression. 

SEC’s Token Embodiment Argument In Its Case Against Binance Case

What happened?

On June 5, 2023, the Securities and Exchange Commission (SEC) filed claims against Binance Holdings Ltd., Binance founder Changpeng Zhao, and related entities alleging that they engaged in the unregistered offer and sale of securities including BUSD and BNB and that they operated Binance as an registered exchange, broker and dealer, and clearing agency. Last Monday, Judge Amy Berman Jackson of the U.S. District Court for the District of Columbia held a hearing for oral argument on Binance’s motion to dismiss.

In the hearing, Binance argued that, in order to qualify as securities pursuant to SEC v. W.J. Howey Co., investment contracts require an actual contract between the parties. Howey held that “an investment contract, for the purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”  Binance’s argument attacks the “contract, transaction or scheme” component, arguing that these require an agreement between parties involved in the transaction. The SEC argued that this interpretation was in direct conflict with legal precedent and that no actual agreement was required by Howey.

The SEC made arguments in line with what has come to be known as the embodiment theory, that “The token itself represents the investment contract . . . the token represents the embodiment of an investment contract.” In other words, the token itself is the security, directly contradicting the SEC’s argument in its case against Coinbase last week. Judge Jackson expressed skepticism over this position, but did not directly address the seemingly contradictory positions of the regulator.

Exemplifying the embodiment argument, the SEC took aim at the promotion of BUSD, highlighting the yield services sold in conjunction with the stablecoin. The SEC argued that BUSD, although pegged at $1.00 USD, was “offered and sold as an investment contract based on opportunity for other profit-yielding measures.” The SEC argued that the initial offering created an investment contract and that, as embodiments of that investment contract, BUSD tokens are securities.

Binance also invoked the Major Questions Doctrine (MQD). This administrative law doctrine requires agency actions which have deep economic and political significance to have a basis in explicit delegations of authority from Congress. Judge Jackson did not seem to agree the doctrine applied, stating: “while this may be a trillion dollar industry, I'm not inclined to think it qualifies under the very narrow circumstances outlined in these cases.”

What does this mean?

This was another instance of the SEC arguing that the token itself embodies an investment contract, sometimes in contradiction to positions it takes in other cases. How the court handles the embodiment argument will be important because it would redefine the regulatory framework for securities and for digital assets. 

If the court buys the SEC’s embodiment theory, and the SEC succeeds in establishing that an initial offering creates an investment contract that travels with the underlying asset itself, that status may flow to secondary transactions as well. This would significantly expand the regulatory oversight of the SEC across multiple asset markets, and would have substantial implications for how assets are traded and managed.


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