Questions of which, if any, regulatory regimes apply to the variety of participants in the cryptocurrency market continue to dog the industry. On February 28, 2022, whether a cryptocurrency futures trading platform constitutes a “futures commission merchant” (“FCM”) under the Commodity Exchange Act (“CEA”) subject to Bank Secrecy Act (“BSA”) regulations took center stage in a U.S. District Court decision denying a motion to dismiss an indictment alleging violations of the BSA against the founders and chief executives of BitMEX.
As we will discuss, the District Court for the Southern District of New York rejected a motion to dismiss the indictment, in which the defendants argued that they lacked notice under the Due Process Clause of the Fifth Amendment that they could face criminal charges based on two technical questions, the answers to which were “unknowable” at the relevant time: (1) whether Bitcoin is a “commodity;” and (2) was BitMEX an FCM brokering cryptocurrency futures.
The criminal charges playing out in federal court are one piece of the extensive enforcement liability faced over the past eighteen months by BitMEX and its founders and chief executives – Arthur Hayes (“Hayes”), Benjamin Delo (“Delo”), Samuel Reed (“Reed”) and Gregory Dwyer (“Dwyer”). We’ve blogged previously on those actions here and here, which center on BitMEX’s alleged failure to adopt and implement an adequate anti-money laundering (“AML”) program.
On the civil side, the Commodities Futures Trading Commission (“CFTC”) initiated a civil enforcement action against the conglomeration of entities comprising BitMEX and Hayes, Delo, Reed and Dwyer, on October 1, 2020. In its Complaint, the CFTC detailed how BitMEX operated with a near total disregard for its compliance obligations under the BSA. BitMEX allegedly lacked proper licensing to conduct business in the United States but deliberately failed to implement know your customer screening to prevent United States-based users from accessing and using their platform, indeed, often taking active steps to mask the true location and identities of its users. This, the Government alleged, made BitMEX an active vehicle for money laundering and sanctions violations, while illustrating conscious efforts to evade U.S. licensing requirements.
On August 10, 2021, the CFTC and the Financial Crimes Enforcement Network (“FinCEN”) jointly announced having reached a $100 million settlement with BitMEX. As FinCEN laid out in its Assessment of Civil Monetary Penalty (the “Assessment”), BitMEX not only allegedly failed to implement “Know Your Customer” (“KYC”) and Customer Identification Program (“CIP”) procedures, it failed in all of its BSA/AML obligations because it : (i) failed to develop an AML program despite receiving warnings about its obligations from other financial institutions; (ii) lacked appropriate compliance personnel; (iii) did not conduct adequate compliance training; (iv) did not independently test its compliance procedures; (v) failed to conduct CIP and transaction monitoring; and (vi) failed to file suspicious activity reports. For these failures, FinCEN assessed a $100 million civil penalty, crediting $50 million of that penalty to BitMEX’s related CFTC settlement. This settlement was secured “[w]ithout [BitMEX] admitting or denying any factual or legal findings or conclusions” set forth in the Assessment. As relevant below, this caveat includes BitMEX neither admitting nor denying its classification as an FCM.
The criminal case against Hayes, Delo, Reed and Dwyer actually preceded the CFTC action by ten days, although it centered on the same deficiencies set forth in the CFTC complaint. The Indictment in that case charged each BitMEX founder with individual violations of the BSA and conspiring to violate the BSA. Like the CFTC proceeding and FinCEN Assessment, the foundation of the criminal charges is BitMEX’s classification as an FCM. The Indictment alleged that the defendants knew that BitMEX had U.S. customers; knew that BitMEX was an FCM subject to the BSA and registration with the CFTC; but attempted to conceal the company’s business in the U.S. Unlike the civil enforcement proceedings, the criminal case cannot resolve without adjudicating the accuracy of BitMEX’s classification as an FCM.
The Motion to Dismiss: Lack of Sufficient Notice of Criminality?
Tackling that issue, Reed, Delo and Hayes moved to dismiss the indictment against them on December 21, 2021 (the “Motion”) (Dwyer’s case had been severed from the other three defendants by order of the Court the week earlier). In the Defendants’ telling, the criminal proceeding “is a test case in which the government seeks to enforce criminally two highly technical statutory regimes in a novel set of circumstances where the line between criminal and innocent conduct was unknowable.” Because that line was “unknowable,” Defendants argued they lacked notice of potential criminal enforcement rendering charges against them violative of their Fifth Amendment due process rights.
Interestingly, while the centerpiece of both Defendants’ and the Government’s position is the classification of BitMEX as an FCM, the Motion did not make that question strictly dispositive. Instead, the Motion lays out that the opacity of that fundamental issue means that “[n]o person of ordinary intelligence could have understood that the executives of an offshore, direct-access exchange for trading cryptocurrency derivatives, as the Indictment alleges BitMEX was, were subject to criminal sanctions under the [BSA] for failing to adopt an [AML] program.” In other words, even if BitMEX is an FCM, the question was uncertain enough that BitMEX’s executives could not have foreseen criminal liability for failing to implement BSA requirements.
To be sure, the application of regulatory regimes in the cryptocurrency market is murky and complex. As relevant to BitMEX, the BSA explicitly defines “financial institution” to include FCMs, which are regulated under the CEA. The CEA, in turn, defines an FCM to include entities “engaged in soliciting or accepting orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market.” This contrasts with entities such as designated contract markets (“DCMs”) and swap execution facilities (“SEFs”), which provide access for users to directly trade futures or options contracts (“DCMs”) or swaps (“SEFs”). Critically, DCMs and SEFs are not subject to the BSA.
Essentially, an FCM is a futures broker and whether BitMEX met that definition required affirmative answers to two questions: (1) is cryptocurrency a commodity; and (2) did BitMEX broker cryptocurrency futures.
So, what is BitMEX? According to the Motion, “the classification of BitMEX as an FCM is far from clear under the CEA and conflicts with available CFTC guidance and historical practice for registration of trading platforms with direct-access features similar to BitMEX.” Defendants did not deny the Indictment’s allegations that BitMEX is “an online trading platform” and “derivatives exchange” that “solicits and accepts orders for trades in . . . futures contracts and other derivative products tied to the value of cryptocurrencies including Bitcoin.” Indeed, on a motion to dismiss an indictment, the Court must accept the factual allegations set forth in the indictment. But, they emphasized the “direct-access features” of the BitMEX platform described in the Indictment when arguing that BitMEX could just as easily be considered a DCM or SEF as it could an FCM. This distinction between a brokering platform and a direct-access platform is vital because, as noted, direct-access platforms do not fall within the BSA.
As to whether they were sufficiently on notice of potential criminal punishment for failure to implement an AML program, defendants argued that because BitMEX offers a first-of-its-kind platform that meets several pre-existing categories of trading platforms that each involve different and, at times, competing legal requirements and liabilities, it is not obvious that BitMEX would legally constitute an FCM as opposed to a DCM or SEF or other trading platform. This lack of clarity, they continue, renders proof of criminal intent to violate the BSA impossible because “[i]t cannot be that Defendants had fair notice that their conduct was criminal when the law regarding BitMEX’s classification as an FCM was ‘vague’ or ‘highly debatable.’”
Additionally, the Defendants broadly challenged whether they were sufficiently on notice as of the alleged commencement of the conspiracy in 2014 that cryptocurrencies were “commodities” under the CEA. Supporting this line of argument, the Defendants cited a variety of agency statements and court opinions spanning the years of the alleged conspiracy demonstrating the various treatments of cryptocurrencies as, among other things, “commodities,” “securities,” and “funds.” In light of this historic uncertainty (if not present uncertainty), they argued they could not reasonably have been expected to know BitMEX was brokering “commodities” and required to register with the CFTC subjecting it to the BSA.
The District Court Opinion
On February 28, 2022, the District Court issued an opinion denying the Motion (the “Opinion”). After originally joining Reed in moving to dismiss the indictment, on February 24, 2022, Hayes and Delo reversed course and entered pleas of guilty to count 1 of the original indictment alleging individual violations of the BSA. Meanwhile, Dwyer’s case had been severed from the other three defendants. Accordingly, the Motion was adjudicated solely as to Reed.
Hewing closely to the low standard of review on a motion to dismiss and the statutory definition of an FCM, the Court explained that “[t]he Indictment alleges that BitMEX literally fell within the statutory definition of an FCM.” As alleged, its business consists of “trad[ing] in, among other things, futures contracts and other derivative products tied to the value of cryptocurrencies including Bitcoin. BitMEX accepts Bitcoin to margin and guarantees its derivative products, and has offered leverage to its customers on certain products.” Essentially because the Indictment tracked the statutory definition of an FCM, the Court accepted those allegations and held the Indictment sufficiently alleged that BitMEX was an FCM.
Next, the Court rejected Reed’s argument that BitMEX’s various features could have made it any one of a variety of platforms, some of which require BSA compliance, others of which do not. The Court simply noted that “the registration categories are not exclusive of one another” and “there appears to be no dispute that BitMEX did not register with the CFTC under any category.”
Turning to whether Reed had sufficient notice that Bitcoin is a commodity under the CEA, the Court emphasized its definition of “commodity” to include “all other goods and articles . . . and all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt with.” The Court concluded, “‘contracts for future delivery’ in cryptocurrencies are ‘dealt in.’ Thus, under the plain language of the CEA, cryptocurrencies fall within the definition of commodities.” Expanding on its reasoning, the Court explained that cryptocurrencies’ share a “core characteristic” “with other commodities whose derivatives are regulated by the CFTC” – that they are “exchanged in a market for a uniform quality and value.” Accordingly, the Court held that “the defendant had adequate notice that cryptocurrencies were commodities within the meaning of the CEA.”
Where does this leave Reed and BitMEX? Trial likely will be scheduled for later this year. Indeed, Dwyer’s trial is already scheduled to commence on October 24, 2022. And, the propriety of BitMEX’s classification as an FCM will continue to be a central focus of the case. As we mentioned and Reed argued, BitMEX’s classification as an FCM is not strictly dipositive in the criminal setting. Criminal punishment for violation of the BSA requires proof a defendant “willfully caused” the underlying BSA violations. Therefore, regardless of the technical classification of BitMEX, the Government will still have to prove beyond a reasonable doubt that Reed understood or should have understood that BitMEX was obligated to implement an adequate AML program. Defending against this element, Reed will certainly continue to focus on the historical and current regulatory treatment of cryptocurrencies, which is likely to lead to interesting pre-trial evidentiary motions practice and more judicial decision-making concerning what cryptocurrencies are and how these issues intersect with criminal procedure.