Attorney General James Proposes Nation-Leading Regulations on Cryptocurrency Industry

 

Crypto Regulation, Protection, Transparency, and Oversight (CRPTO) Act Would Eliminate Conflicts of Interest, Increase Transparency, and Impose Commonsense Measures to Protect Investors

New York Attorney General Letitia James announced landmark legislation to tighten regulations on the cryptocurrency industry to protect investors, consumers, and the broader economy. The multi-billion-dollar industry lacks robust regulations, making it prone to dramatic market fluctuations, and has been used to hide and facilitate criminal conduct and fraud. Attorney General James’ program bill, which proposes the strongest and most comprehensive set of regulations on cryptocurrency in the nation, would increase transparency, eliminate conflicts of interest, and impose commonsense measures to protect investors, consistent with regulations imposed on other financial services.

The bill would require independent public audits of cryptocurrency exchanges and prevent individuals from owning the same companies, such as brokerages and tokens, to stop conflicts of interest. Crypto platforms would also have responsibilities to customers similar to banks under the federal Electronic Fund Transfer Act by requiring platforms to reimburse customers who are the victims of fraud. The bill would also strengthen the New York State Department of Financial Services’ (DFS) regulatory authority of digital assets.

“Rampant fraud and dysfunction have become the hallmarks of cryptocurrency and it is time to bring law and order to the multi-billion-dollar industry,” said Attorney General James. “New York investors should have the peace of mind that there are safeguards in place to protect them and their money. All investments are regulated to account for every penny of investors’ money — cryptocurrency should be no exception. These commonsense regulations will bring more transparency and oversight to the industry and strengthen our ability to crack down on those that don’t pay respect to the law.”

Overview of the Crypto Regulation, Protection, Transparency, and Oversight (CRPTO) Act:

Millions of investors have lost hundreds of billions in the value of their cryptocurrency investments because of rampant fraud, including market manipulation, hacking, and opaque business practices. Currently, the cryptocurrency industry lacks a robust regulation regime that would prevent or intercept fraud and market failures. While there are millions of investors who have lost significant investments because of these failures, lower income investors and people of color have been disproportionately harmed by the risks of crypto. A study by the JPMorgan Chase Institute on investments made before the 2022 collapse in cryptocurrency values found that lower income households bought crypto at substantially higher prices, and as a result, those lower income households bore a disproportionate share of the losses when the bubble burst.

Additionally, as cryptocurrency investments have been marketed directly to minority communities, the people most susceptible to fraud and losing significant funds due to financial collapses are disproportionately vulnerable and marginalized Americans. Attorney General James’ bill seeks to protect New York investors by bringing regulations and oversight that are applied to other financial services to the cryptocurrency industry and addressing risky practices that are unique to crypto.

1. Stop Conflicts of Interest

The cryptocurrency industry is rife with conflicts of interest that harm investors and reduce competition. In one example, crypto company Terraform Labs created a token, Luna, and also created a lending platform, Anchor, that promised 20 percent interest to customers who invested in Luna on Anchor. But investors could only access the 20 percent returns if they purchased another token created by Terraform Labs called Terra. Because Terraform Labs owned Luna and Terra and promised these unsustainable high interest rates, the actual value of the digital assets was masked from everyday investors and set the table for market disaster. Under current law, there is no regulation or prohibition against these obvious conflicts of interest that put crypto investors at risk.

The bill would stop conflicts of interest in the industry by:

• Preventing common ownership of crypto issuers, marketplaces, brokers, and investment advisers and preventing any participant from engaging in more than one of those activities;
• Preventing crypto brokers and marketplaces from trading for their own accounts;
• Prohibiting marketplaces and investment advisers from keeping custody of customer funds;
• Prohibiting brokers from borrowing or lending customer assets; and
• Prohibiting referrals from marketplaces to investment services for compensation.

2. Require Public Reporting of Financial Statements

Too often investors are unaware of the real risks of investing in cryptocurrencies because crypto companies are not required to make critical public disclosures of their financial condition. As a result, most companies do not make any public disclosures and some companies have even publicly misrepresented their financial condition. For example, Celsius, a cryptocurrency lending platform, bought up its own token, Cel, resulting in an inflated price of Cel and an appearance of demand for Cel, which did not actually exist. When Celsius ultimately froze customer withdrawals and filed for bankruptcy, many investors were caught by surprise, especially in light of repeated statements by the company and its CEO Alex Mashinsky that Celsius had billions of dollars of liquidity.

The bill would increase transparency in the industry by requiring companies to, among other things:

• Undergo mandatory independent auditing and publish audited financial statements;
• Provide investors with material information about issuers, including risks and conflict-of-interest disclosures;
• Require marketplaces to establish and publish listing standards; and
• Require cryptocurrency promoters to register and report their interest in any issuer whose crypto assets they promote.

3. Bolster Investor Protections

Cryptocurrency companies — unlike banks — lack insurance for customer deposits, which makes these companies at significant risk of an old-fashioned “bank run” if they get into trouble. At the same time, crypto companies often lack comprehensive oversight and reserve requirements to ensure they can meet consumer demand or obligations. Multiple cryptocurrency companies have gone bankrupt, losing billions of dollars in investments with no recourse for investors. Additionally, due to inadequate cybersecurity measures, many crypto brokers and marketplaces have lost billions of dollars of customers’ crypto assets. In 2021, cybercriminals raked in at least $14 billion in stolen digital assets. Currently, the law does not protect investors’ cash or provide a means for returning an investor’s crypto holdings if a crypto exchange, broker, or platform fails.

The bill would bolster investor protections by:

• Enacting and codifying “know-your-customer” provisions, meaning brokers would have to know essential facts about their customers, and requiring crypto brokers and marketplaces to only conduct business with firms that comply with KYC provisions;
• Banning the use of the term “stablecoin” to describe or market digital assets unless they are backed 1:1 with U.S. currency or high-quality liquid assets as defined in federal regulations; and
• Requiring platforms to reimburse customers who are the victims of unauthorized asset transfers and transfers resulting from fraud.

The bill would grant the Attorney General jurisdiction to enforce any violation of the law, issue subpoenas, impose civil penalties of $10,000 per violation per individual or $100,000 per violation per firm, collect restitution, damages, and penalties, and shut down businesses engaging in fraud and illegality. The bill would also codify DFS’ authority to license digital asset brokers, marketplaces, investment advisors, and issuers prior to engaging in business in New York and allow DFS to oversee the digital asset licensing regime.

“The cryptocurrency industry is in need of regulation and oversight,” said New York State Comptroller Thomas P. DiNapoli. “As the financial capital of the world, New York must lead these efforts. I applaud Attorney General James for taking decisive action to protect the public.”

“The lack of transparency plaguing the crypto industry causes immense harm to countless investors, especially low-income New Yorkers and people of color who carry a disproportionate share of the losses,” said New York City Comptroller Brad Lander. “We cannot let the crypto industry operate without a basic infrastructure for accountability. With this bill, Attorney General Letitia James is addressing the urgency for greater oversight of the crypto industry and building a legal framework to protect New Yorkers and the economy from predatory companies.”

This program bill will be submitted by OAG to the State Senate and Assembly for their consideration during the 2023 legislative session.

This announcement is the latest effort by Attorney General James to rein in the cryptocurrency industry. In March, Attorney General James continued her efforts to crack down on unregistered cryptocurrency platforms by filing a lawsuit against KuCoin for failing to register as a securities and commodities broker and falsely representing itself as a marketplace. In February, Attorney General James brought action against CoinEx for similarly failing to register as a securities and commodities broker. In January, Attorney General James and a multistate coalition recovered $24 million from the cryptocurrency platform Nexo for operating illegally and sued the former CEO of Celsius for defrauding investors and concealing the company’s dire financial condition. In November 2022, Attorney General James urged congress to adopt legislation that would prohibit investing retirement funds in cryptocurrencies. In June 2022, she warned New Yorkers of the dangerous risks of investing in cryptocurrencies after the market reached then-record lows. Also in June 2022, Attorney General James reached a nearly $1 million settlement with crypto platform BlockFi Lending LLC for offering unregistered securities. Last March, Attorney General James issued a taxpayer notice to virtual currency investors and their tax advisers to accurately declare and pay taxes on their virtual investments. In October 2021, Attorney General James directed unregistered crypto lending platforms to cease operations for not registering with the state.