Bitcoin Prices Continue Volatile Surge Despite Increasing Regulatory Scrutiny

In recent days, Bitcoin prices have surged past $11,000 before dropping back to around $10,000. This represents a more than 1000% growth since the start of 2017. In the last month alone, the price has more than doubled. This surge follows the announcement by the CME Group, the world’s leading derivatives marketplace, to launch Bitcoin futures on December 18. CBOE Global Markets Inc. also intends to launch a Bitcoin futures soon. Both received a green light from the CFTC today, December 1, through the process of self-certification – a pledge that the products do not run afoul of the law. There are also rumors that NASDAQ will launch a futures contract based on Bitcoin in 2018.

Bitcoin is a cryptocurrency, a digital asset designed to work as a medium of exchange using cryptography to secure the transaction and verify the transfer of assets with no need for a bank or other middleman. It is one of many new virtual currencies. Many startups have attempted “Initial Coin Offerings” or ICOs to raise funds in an attempt to create a new virtual currency. Other startups have attempted to launch various platforms as exchanges or ways to utilize Bitcoin and similar virtual currencies.

The SEC, CFTC, and other regulators in the United States and around the world are taking an active role in regulating Bitcoin and other cryptocurrencies and bringing enforcement actions when necessary.

As early as 2013, the SEC’s office of Investor Education and Advocacy issued an investor alert on Ponzi schemes using virtual currencies. In July of this year, the SEC Division of Enforcement issued an investigative report “cautioning market participants that offers and sales of digital assets by ‘virtual’ organizations are subject to the requirements of the federal securities laws.” In March of 2017, the SEC rejected a bitcoin ETF on the basis that “significant markets for bitcoin are unregulated.” So far, no ETFs have been approved. In August, the SEC temporarily suspended the trading activity of three public companies that indicated they were likely to engage in an “initial coin offering” for a new digital currency. Earlier this month, the SEC Division of Enforcement issued a statement warning that celebrity endorsements of initial coin offerings and similar investments may be unlawful if they “do not disclose the nature, source, and amount of any compensation paid, directly or indirectly, by the company in exchange for the endorsement.”

Since 2015, the CFTC has taken the position that it views Bitcoin and other virtual currencies as commodities under the Commodity Exchange Act. Coinflip operated a trading platform with put and call options for Bitcoins in 2014 but did not follow regulations under the Commodity Exchange Act. Coinflip agreed to a settlement with the CFTC. It was not subject to a fine but was required to cease and desist from violating the act as well as subject to additional undertakings. As part of its order, the CFTC for the first time found that Bitcoin and other virtual currencies are properly defined as commodities. Aitan Goelman, the CFTC’s Director of Enforcement, commented: “While there is a lot of excitement surrounding Bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.” On October 4, 2017, the CFTC issued a “Primer on Virtual Currencies.” The primer warns of the extensive risk of fraud with virtual currencies and reaffirms the CFTC’s enforcement authority.

Bitcoin’s future is still uncertain. Goldman Sachs CEO Lloyd Blankfein tweeted in October that “Still thinking about #Bitcoin. No conclusion – not endorsing/rejecting. Know that folks also were skeptical when paper money displaced gold.” Others have made up their mind. At a Barclay’s conference in September, J.P. Morgan’s Jaime Dimon called Bitcoin “a fraud worse than tulip bulbs.” A common critique of Bitcoin is that it is mostly used by tax evaders, money launders, and others wanting to avoid government scrutiny. Such secrecy may not last. The IRS recently won a court victory over Coindesk, one of the top Bitcoin exchanges, in a demand for a list of all Bitcoin users making transactions worth more than $20,000. The case is U.S. v. Coinbase, 17-01431, U.S. District Court, Northern District of California (San Francisco).

Companies utilizing virtual currencies may be using the money of the future, but they will face the regulators of today.

Update: IRS, SEC, and Courts Diverge on Nature of Disgorgement

We previously wrote about decisions in SEC v. Graham from the Eleventh Circuit,  __ F.3d __, No. 14-13562, 2016 WL 3033605 (11th Cir. May 26, 2016), and the U.S. District Court for the Southern District of Florida, 21 F. Supp. 3d 1300 (S.D. Fla. 2014), considering whether disgorgement claims and other remedies were subject to five-year statute of limitations on actions “for the enforcement of any civil fine, penalty, or forfeiture” codified in 28 U.S.C. § 2462. The Eleventh Circuit affirmed the decision of the lower court that the SEC’s disgorgement claims were time-barred, holding that “disgorgement” is synonymous with the plain meaning of “forfeiture” as it is used in the statute.

On May 6, 2016—shortly before the Eleventh Circuit issued its ruling in Graham—the IRS published non-precedential Chief Counsel Advice (“CCA”) on whether Internal Revenue Code Section 162(f) bars business expense deductions for disgorgement paid to the SEC of profits stemming from alleged violations of the Foreign Corrupt Practices Act (“FCPA”). The disgorgement payments were part of a consent agreement between the SEC and the taxpayer, whose subsidiary allegedly falsified accounting records in order to conceal gifts it made to officials of a foreign government in exchange for business benefits. The taxpayer paid additional penalties for which it specifically agreed it would not seek a tax deduction in a parallel agreement with the DOJ relating to the criminal case against taxpayer’s subsidiary. The IRS concluded that the taxpayer’s disgorgement payments were not deductible business expenses under § 162(f), which prohibits deduction of any “fine or similar penalty paid to a government for the violation of any law” as a business expense.

As explained in the CCA, § 162(f) has been interpreted to bar deductions of civil penalties where they are “imposed for purposes of enforcing the law and as punishment,” but to allow deduction of civil penalties if “imposed to encourage prompt compliance with a requirement of the law”—for example, “late filing charges or other interest charges”—or “as a remedial measure to compensate another party.”  Emphasizing that disgorgement in securities cases has deterrent aims, is a discretionary remedy, and might be required even if there is no injured party or in amounts exceeding actual losses, the IRS determined that whether disgorgement is primarily punitive or primarily compensatory for the purpose§ 162(f) is a fact-specific inquiry. Additionally, disgorgement imposed as a “discretionary equitable remedy” or where the proceeds are used to compensate victims might still be primarily punitive if it resembles forfeiture, which remains non-deductible even when used to compensate victims. With respect to the FCPA disgorgement the taxpayer had made to the SEC, the IRS concluded that its purpose was primarily punitive, and therefore it could not be deducted, because there was no evidence that it was meant to compensate the government or some other party for loss.

The SEC, the IRS, and the Eleventh Circuit have thus articulated three distinct characterizations of disgorgement. To avoid the limitations period of § 2462, the SEC’s position, adopted by the D.C. Circuit in Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996), has been that disgorgement is a non-punitive equitable remedy. In the IRS’s view, disgorgement to the SEC may—but perhaps does not always—have a punitive purpose that bars tax deduction. The Eleventh Circuit has equated the statutory definitions of disgorgement and forfeiture, without commenting on whether disgorgement to the SEC is a “penalty.”

©2023 Faegre Drinker Biddle & Reath LLP. All Rights Reserved. Attorney Advertising.
Privacy Policy