Over the last several months, and with increasing escalation in recent weeks, liquidity crises and a lack of responsible governance at cryptocurrency exchanges and other prominent crypto-intermediaries have roiled the digital asset ecosystem. A series of bankruptcy filings reveals a grim portrait of some of the most egregious corporate governance and risk management failures in recent financial markets history.[1] All too often, the details reveal little, if any, attempt to effectuate even minimal corporate governance through board oversight; management remarkably characterized by dereliction of duty; staggering, undisclosed conflicts of interest; commingling of customer funds with the proprietary assets of trading firms or related entities; lending or reinvestment of customer funds in highly risky asset classes; no evidence of audited financial statements; and sophisticated Ocean’s Eleven cyber-heists as well as traditional garden variety-styled fraud.[2]
Five years ago, concerned that events like these might unfold in our markets, on our shores, or across multiple jurisdictions, I began to raise alarms. As I previously warned, “infrastructure challenges, consumer protection concerns, mismanagement, misconduct, fraud, market manipulation, and predatory trading tactics” throughout the crypto-ecosystem may present a clear and present danger for customers and creditors and, depending on correlations and the creep of contagion, threaten the integrity of traditional financial markets.[3]
As we unravel the tangled web of interconnected financial transactions and relationships among cryptocurrency trading platforms facing liquidity crises, we should anticipate a season of mergers, acquisitions, and consolidation. It will be important to consider not only the effects of contagion among related entities, but the importance of due diligence and related acquisition processes. We must ensure effective competition among the robust, resilient, well-supervised, exchanges and intermediaries that operate in the cryptocurrency ecosystem.
The events that we have witnessed should encourage us to take two steps with all deliberate speed. First, I have continuously advocated internally and externally for the Commodity Futures Trading Commission (CFTC) to use our existing authority to further mitigate potential risks to all customer assets held by all current registrants or licensed participants operating in our markets, as well as prospective registrants.[4] We have, in the context of certain regulated market activities, carefully crafted customer protections that require the segregation of customer assets. Beyond relying on fraud and market manipulation enforcement actions, we should explore ways to ensure that these rules apply in the context of proposed alternative market structures as well. Such efforts would close a regulatory gap and ensure a parallel standard applies to segregation of custodied customer assets or customer property in all contexts. Second, I am hopeful that Congress will identify a whole-of-government approach to ensure that we prevent schemes that rely on regulatory arbitrage or take advantage of the regulatory gap that currently limits our visibility into digital asset trading markets and stymies our ability to adopt rules necessary to effectuate our mission in these markets - to protect customers, ensure market integrity, and foster fair, orderly, and transparent markets.
I note that today we see an illustration of one more instance of the CFTC’s best efforts to use our existing authority to protect customers. Today, the CFTC announced the entry of a consent order for permanent injunction and other equitable relief against Defendant Jeremy Spence (“Consent Order”) by the Hon. John G. Koeltl of the United States District Court for the Southern District of New York. Specifically, the Consent Order finds that, from approximately December 2017 to April 2019, Spence operated a digital Ponzi scheme under the name "Coin Signals" designed to defraud cryptocurrency investors. Spence’s scheme captured more than $5 million in cryptocurrencies from approximately 175 user accounts.
Spence enticed customers using various social media platforms and touting an engineered trading record, imagined list of assets under management, and creatively crafted description of highly profitable returns. Through his duplicity, Spence was able to rack up significant trading losses. Consistent with Charles Ponzi’s original, old-school scheme Spence distributed current customer funds to newly solicited investors describing the same as "profits."
I want to recognize the hard work of the Division of Enforcement expressly. I also want to commend the Division staff for bringing this action, including Elizabeth Brennan, Brent Tomer, Lenel Hickson, Jr., and the Office of the General Counsel.
While Spence’s prison term will limit his ability to continue this scheme, other bad actors stand ready, willing, and able to take his place and prey on victims’ hopes and fears. Accordingly, I strongly encourage members of the public to stay informed about the potential scams and abuses in the digital assets markets by visiting our investor advisory page.[5]
[1] See In re FTX Trading Ltd., No. 22-BK-11068 (Bankr. D. Del.); In re BlockFi Inc., No. 22-BK-19361 (Bankr. D.N.J.); In re Celsius Network LLC, No. 22-BK-10964 (Bankr. S.D.N.Y.); In re Three Arrows Capital, Ltd., No. 22-BK-10920 (Bankr. S.D.N.Y.); In re Voyager Digital Ltd., No. 22-BK-10944 (Bankr. S.D.N.Y.); see also David Yaffe-Bellany & Erin Griffith, How a Trash-Talking Crypto Founder Caused a $40 Billion Crash, N.Y. Times, May 18, 2022 (describing the crash of the TerraUSD Luna stablecoin pair).
[2] See, e.g., Declaration of John J. Ray III in Support of Chapter 11 Petitions and First Day Pleadings at ¶ 5, In re FTX Trading Ltd., No. 22-BK-11068 (Bankr. D. Del. Nov. 17, 2022), ECF No. 24 (“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”).
[3] See e.g.,Kristin N. Johnson, Regulating Cryptocurrency Secondary Mkt. Trading Platforms, 1/8/2020 U. Chi. L. Rev. Online 1 (2020); https://lawreviewblog.uchicago.edu/2020/01/07/298/,
Kristin N. Johnson, Disintermediation and Decentralization in Fin. Mkts., Regul. Rev., May 4, 2021, https://www.theregreview.org/2021/05/04/johnson-disintermediation-decentralization-financial-markets/.
[4] Kristin N. Johnson, Commissioner, CFTC, Keynote Address at the Stanford Crypto Policy Conference (Nov. 15, 2022); Kristin N. Johnson, Commissioner, CFTC, Keynote Address at the 2022 Federal Reserve Bank of Chicago Financial Markets Group Fall Conference on Innovation in Trade Execution, Governance, and Post-Trade Clearing and Settlement of Exchange Traded and Centrally Cleared Products (Nov. 16, 2022).
[5] See, CFTC Customer Advisory: Be Alert and Share Information to Help Seniors Avoid Fraud (issued June 15, 2022); CFTC Customer Advisory: Avoid Forex, Precious Metals, and Digital Asset Romance Scams (issued Feb. 2, 2022); CFTC Investor Alert: Watch Out for Fraudulent Digital Asset and "Crypto" Trading Websites (issued Apr. 26, 2019); CFTC Customer Advisory: Use Caution When Buying Digital Coins or Tokens (issued July 16, 2018); CFTC Customer Advisory: Beware Virtual Currency Pump-and-Dump Schemes (issued Feb. 15, 2018); CFTC Customer Advisory: Beware "IRS Approved" Virtual Currency IRAs (issued Feb. 2, 2018); and CFTC Customer Advisory: Understand the Risks of Virtual Currency Trading (issued Dec. 15, 2017), available https://www.cftc.gov/LearnAndProtect/AdvisoriesAndArticles/index.htm.
