Going forward, it looks like crypto companies that make it in
New York will be able to make it anywhere. All over, at the state
and federal level and internationally, turmoil in the crypto
industry is leading to increased scrutiny. In New York, home of the
comprehensive (some would say onerous) BitLicense, cryptocurrency
mining has been partially banned and the New York State
Department of Financial Services (DFS) is adding more rules for
crypto companies to follow. It’s not all whips and chains,
however, as a short leash has been granted to support the industry
as discussed below.
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90-Day Crypto Banking
On December 15, 2022, DFS published industry guidance pertaining to New
York-registered banks approved to conduct virtual currency business
(such banks are generally exempt from the BitLicense regulation).
The guidance explains that if a bank received prior approval to
engage in crypto activities that “does not constitute general
consent for [such NY bank] to engage in other types of virtual
currency-related activity.”
Instead, the DFS now expressly requires NY banks to seek
approval from DFS within 90 days before “commencing any new or
significantly different virtual currency-related activity.”
Notably, DFS approval may be required even for crypto activity
performed by a third party engaged by a NY bank.
If the DFS informs the bank that formal approval of the proposed
activity is required, the bank will have to prepare a written
submission, which must set forth the following:
- a business plan,
- legal/regulatory analysis, and
- a summary of the applicable risk management and corporate
governance frameworks, consumer protection procedures and
financials.
DFS Nixes Crypto Commingling
On January 23, 2023, the DFS also issued guidance for
BitLicensed companies and limited purpose trust companies that
provide crypto custodial services. The guidance
requires crypto custodians to separately account for and segregate
customer crypto from the custodian’s own assets. Though,
omnibus wallets (i.e., that hold crypto of multiple customers) are
permitted so long as certain conditions are met, such as the
custodian maintains a clear internal audit trail to identify each
customer’s assets.
In addition, and apparently in direct response to the
FTX/Alameda fiasco, New York now expressly only permits crypto
custodians to take possession of crypto for the limited purpose of
carrying out custody and safekeeping services. Custodians cannot
use crypto for the custodian’s own use, e.g., using it to
secure or guarantee an obligation of the custodian.
Crypto custodians also must disclose to their customers, among
other things, (i) how it segregates and accounts for customer
crypto, (ii) the property interest the customer retains in the
assets and (iii) how the custodian can use the assets while they
are in its possession.
More State Regulations Coming
In the coming months, DFS and perhaps even New York lawmakers
may be working on more rules and regulations for crypto companies
to follow
Perhaps a sign of tough love, New York may also be taking steps
to support the industry. For example, a new bill has been introduced that would allow
state agencies “accept crypto for payments related to taxes,
rent, fines, penalties, interest, and so on through agreements with
individuals and groups.”
Across the Hudson, another state is looking to clamp down on
crypto. The proposed “Digital Asset and Blockchain Technology
Act” is currently working its way through the New Jersey
Senate. The Blockchain Association recently criticized the
bill, asserting it “would effectively outlaw all of the crypto
businesses that are currently thriving in the Garden State” is
so overly broad that “even airline miles could be prohibited
from being offered to New Jersey residents.”
Another Crypto Clawback Waive Crashes
In other crypto news, and as discussed in our prior article on crypto clawbacks, the tide of
lawsuits seeking to clawback crypto is rolling and picking up
steam. Last month, Alameda (FTX’s trading arm) filed a preference action against bankrupt lender
Voyager Digital, to claw back $446 million in funds transferred to
Voyager prior to Alameda’s own bankruptcy filing.
Interestingly, Alameda describes Voyager as a “feeder
fund” and alleges that it “solicited retail investors and
invested their money with little to no due diligence in
cryptocurrency investment funds like Alameda and Three Arrows
Capital.” Alameda further asserts the automatic stay
doesn’t apply because the at-issue transfers were made after
the filing of Voyager’s bankruptcy.
Looking Ahead
Political crypto clawbacks may be next. That is, FTX has
demanded that the political figures and groups that received donations from Sam Bankman-Fried and other FTX
leaders return the funds by the end of this month. If any donations
are not returned, we can expect to see legal action to follow.
Also, a broader trend for participants to be mindful of is
litigation against backers of crypto firms, such as the class
action recently filed against Sequoia Capital related to FTX. There,
the plaintiffs claim that Sequoia’s involvement and public
statements legitimized FTX’s operations, which induced
plaintiffs to transact business with FTX. Key issues regarding
investor duties and the reasonableness of diligence may be decided,
with implications beyond crypto to other markets. In particular,
the District Court may weigh in on the scenario where a party sues
arguing that they relied on the truth and accuracy of statements or
diligence of others. For example, the analysis may apply to
investors in ESG funds claiming against fund managers who relied on
a target’s representation that turned out to be false or a
cannabis REIT subject to claims by its investors for
misrepresentations made by the REIT’s tenant, which allegedly
should have been discovered.
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