CFTC Pham warns KuCoin lawsuit undermines investor protection laws

Rick Steves

“The CFTC’s approach may infringe upon the SEC’s authority and undermine decades of robust investor protection laws by conflating a financial instrument with a financial activity, disrupting the foundations of securities markets.”

CFTC Commissioner Caroline D. Pham released a statement in response to the recent enforcement action against crypto exchange KuCoin.

While commending the CFTC’s Division of Enforcement for its vigilance, she also expresses reservations about certain legal interpretations made in the complaint.

“Owning shares is not the same thing as trading derivatives”

Caroline D. Pham’s concern centers on the treatment of fund shares, typically classified as securities and thereby falling under the regulatory purview of the Securities and Exchange Commission (SEC), as equivalent to engaging in leveraged trading as defined under section 2(c)(2)(D) of the Commodity Exchange Act.

The Commissioner highlights a potential jurisdictional conflict between the CFTC and the SEC, pointing out that the approach taken in the complaint could blur the lines between investment in funds (a security) and the trading activities of a fund (allegedly under CFTC jurisdiction). She warns that such conflation between financial instruments and activities could infringe upon the SEC’s authority and disrupt longstanding investor protection laws by failing to distinguish between owning shares and trading derivatives.

“The CFTC has filed another aggressive enforcement action exercising our authority to pursue alleged unregistered crypto asset derivatives trading platforms and other violations of law. I commend the Division of Enforcement’s vigilance in protecting our markets. However, I note that the complaint appears to assert that fund shares held by investors—namely, securities—can themselves constitute leveraged trading pursuant to section 2(c)(2)(D) of the Commodity Exchange Act. This interpretation fails to distinguish between an investment in a fund, which would typically be a security under the jurisdiction of the SEC, and the trading activities of a fund, alleged here to be under the CFTC’s jurisdiction. The CFTC’s approach may infringe upon the SEC’s authority and undermine decades of robust investor protection laws by conflating a financial instrument with a financial activity, disrupting the foundations of securities markets. Owning shares is not the same thing as trading derivatives.”

CFTC sued KuCoin last week

Last week, the CFTC filed a complaint against KuCoin, which is operated by four entities: Mek Global Limited, PhoenixFin PTE Ltd., Flashdot Limited, and Peken Global Limited. The crypto exchange allegedly:

  • illegally dealt in off-exchange commodity futures transactions and leveraged, margined, or financed retail commodity transactions;
  • solicited and accepted orders for commodity futures, swaps, and leveraged, margined, or financed retail commodity transactions without registering with the CFTC as a futures commission merchant (FCM);
  • failed to diligently supervise its FCM activities; operated a facility for the trading or processing of swaps without registering with the CFTC as a swap execution facility (SEF) or designated contract market (DCM);
  • and failed to implement an effective customer identification program (CIP).

The CFTC complaint alleges that KuCoin offered and executed commodity derivatives and leveraged, margined, or financed commodity transactions to and for people in the U.S. from approximately July 2019 to approximately June 2023, and failed to implement required know-your-customer (KYC) compliance procedures.

The complaint further alleges that although KuCoin claimed to have implemented KYC procedures, those procedures were a sham and did not prevent U.S. customers from trading commodity interests and derivatives on the platform.

The CFTC also claims people who identified themselves as being U.S. customers were permitted to trade commodity futures, swaps, and leveraged, margined, or financed commodity transactions on the exchange, in violation of the CEA and CFTC regulations.

KuCoin failed to impose any IP address restrictions during the relevant period to prevent U.S. customers from trading commodity interests or accounting for commonly used technology such as virtual private networks (VPNs) that could potentially circumvent IP address restrictions.

The lack of customer identity verification and failure to report suspicious activities has led to the platform facilitating over $9 billion in suspicious transactions, according to US Attorney Damian Williams.

KuCoin users withdrew over $1.19 billion

Following the lawsuit, KuCoin announced plans to distribute $10 million worth of Bitcoin and its native KCS token via an airdrop event. The CEO drew parallels between the airdrop and the exchange’s past initiative to reimburse investors affected by the Confido rug pull.

The airdrop comes amid growing concerns that led to increased withdrawal volumes and customer apprehension. Additionally, the decision to proceed with an airdrop is not without its risks, particularly from a regulatory standpoint.

The Securities and Exchange Commission (SEC) said earlier that airdrops, even when free of monetary exchange, could still meet the criteria of an “investment of money” under the Howey test, potentially classifying them as securities distributions.

Data from Spot on Chain indicates that net outflow from KuCoin surpassed $1.19 billion. Despite these withdrawals, KuCoin still holds assets worth roughly $4.02 billion. The exchange also experienced delays in transactions, fueling speculation about its stability. However, KuCoin has sought to reassure its user base of over 30 million customers through a statement on X, emphasizing that the platform is operating normally and user assets are secure.

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