SEC Rejects Proposal to List Bitcoin-Based ETP on Regulated Exchange

By a three-to-one vote, the SEC rejected a second application by the Bats BZX Exchange (“BZX”) (now owned by Cboe Global Markets) to list a bitcoin-backed exchange-traded product (“ETP”). The proposal, which was previously rejected by the SEC Division of Trading and Markets, would have permitted the listing and trading of shares of the “Winklevoss Bitcoin Trust.” The ETP would have (i) held only bitcoins as an asset and (ii) tracked the price of bitcoin on the Gemini Exchange, a cryptocurrency exchange founded by Cameron and Tyler Winklevoss. To date, the SEC has not approved a cryptocurrency-backed ETP.

Exchange Act Section 6(b)(5) requires that the rules of a national securities exchange be designed to (i) “prevent fraudulent and manipulative acts and practices” and “protect investors and the public interest.” In its Order, the SEC asserted that the price of bitcoin can be (and has been) manipulated through activity on bitcoin trading venues. The SEC rejected the claim by BZX that it could monitor the Gemini Exchange for potential price manipulation, finding that the Gemini Exchange did not materially represent the bitcoin market. The SEC pointed to BZX’s lack of surveillance-sharing agreements with significant, regulated markets as inconsistent with SEC-approved commodity-trust ETPs. The SEC further rejected the argument that bitcoin spot markets are inherently resistant to manipulation due to the decentralized nature of blockchain technology. In sum, the SEC found that BZX failed to establish that its various surveillance proposals were sufficient to protect investors from fraud as required to comply with Exchange Act Section 6(b)(5).

Commissioner Hester Peirce dissented from the SEC order and argued that the BZX proposal met the Exchange Act Section 6(b)(5) standard. Ms. Peirce contended that her fellow Commissioners focused too heavily on the shortcomings of the underlying bitcoin spot market, and failed to give proper consideration to BZX’s surveillance and fraud detection capabilities. She asserted that many commodity-based ETPs would be in danger if the Order’s standard for bitcoin were universally applied. Further, Ms. Peirce stated that the outcome undermined investor protection and represented a missed opportunity to institutionalize and legitimize the bitcoin market.

GAO Calls for Urgent Action to Address Nationwide Cybersecurity Challenges

In a study conducted to update its identification of information security risk areas, the Government Accountability Office (“GAO”) identified four primary cybersecurity challenges and ten corresponding actions that the federal government and other entities must undertake to address them.

The four challenges are (i) establishing a comprehensive cybersecurity strategy and performing effective oversight, (ii) strengthening federal systems and information, (iii) safeguarding cyber critical infrastructure, and (iv) protecting privacy and sensitive data.

The four actions needed to address the first challenge are:

  • developing a more exhaustive federal strategy for national cybersecurity;
  • mitigating global supply chain risks;
  • addressing cybersecurity workforce management challenges (since the federal government faces challenges with respect to ensuring that the nation’s cybersecurity workforce has the necessary skills); and
  • ensuring the security of emerging technologies (such as artificial intelligence and the Internet of Things).

The three actions outlined to deal with the second challenge are:

  • improving the implementation of government-wide cybersecurity initiatives;
  • addressing weaknesses in federal agency information security programs; and
  • bolstering the federal response to cyber incidents.

To confront the third challenge, the GAO identified the need for a more robust federal role in protecting the cybersecurity of critical infrastructure (such as electricity grids and telecommunications networks).

With regard to tackling the fourth challenge, the GAO called for improving federal efforts to protect privacy and sensitive data, limiting the collection and use of personal information, and ensuring that personal information is obtained with appropriate knowledge or consent.

Since 2010, the GAO has made over 3,000 recommendations to federal agencies that relate to mitigating cybersecurity weaknesses. As of July 2018, approximately 1,000 recommendations still need to be implemented.

U.S. Agencies Warn Businesses of North Korean Sanctions Evasion Tactics

In an advisory titled: Risks for Businesses with Supply Chain Links to North Korea, the U.S. State Department, the U.S. Treasury Department Office of Foreign Assets Control, and the U.S. Department of Homeland Security Customs and Border Protection and Immigration and Customs Enforcement (the “agencies”) warned of tactics used by North Korea to evade sanctions.

The agencies warned businesses that falling for attempts by North Korea to evade U.S. and UN trade and labor sanctions could subject those businesses to legal liability. The agencies emphasized two primary areas of risk for businesses: (i) unintentionally sourcing services, goods or technology from North Korea and (ii) having North Korean citizens or nationals, whose labor produces revenue for the North Korean government, in a company’s supply chains.

The agencies urged businesses to implement necessary due diligence best practices, and to review their supply chains for North Korean laborers, goods and services.

CFTC Leaders Respond to Criticisms Raised in Vatican Document

CFTC Chair J. Christopher Giancarlo and CFTC Chief Economist Bruce Tuckman responded to criticisms outlined in the Bollettino, a document released by the Vatican that “lays out ethical foundations to govern economic and financial systems.” The CFTC leaders defended derivatives and credit default swaps (“CDS”), which were subject to particular scrutiny in the document.

Mr. Giancarlo and Mr. Tuckman emphasized that it is important to recognize the “social utility” of derivatives. They asserted that derivatives products help to “moderate price, supply and other commercial risks” which can facilitate economic growth and prosperity. Additionally, they highlighted that derivatives can be tools for risk transfer and mitigation, particularly in agricultural communities.

Notably, Mr. Giancarlo and Mr. Tuckman argued that in order for agricultural exporting nations to help “feed the world’s growing population,” they must have support from derivatives markets. They added that derivatives markets play a significant role in aiding return on capital, which they said supports investments in various farming technologies that are necessary to meet the global food demand.

Mr. Giancarlo and Mr. Tuckman focused on three specific issues related to CDS: (i) information asymmetries, (ii) speculation and (iii) profiting from the suffering of others. They argued that information asymmetry is an inherent aspect of a healthy financial system and that speculation contributes to the “generation of information and the dissemination of that information to the public at large.” They stated that proper uses of CDS “require a counterparty on the other side of the trade,” and speculators fulfill this role. Mr. Giancarlo and Mr. Tuckman further asserted that research shows that CDS trading on sovereign bonds (i) “lowers countries’ cost of debt and increases the information efficiency of their bond markets” and (ii) acts as “an important check on poor fiscal management.”

Mr. Giancarlo and Mr. Tuckman concluded that derivatives “help stabilize the price of global commodities and financial rates in a manner that is particularly beneficial to the world’s poor.”

Lofchie Comment: It is important that participants in our capitalist system be willing to step up to its defense, educate as to its social benefits and engage with its well-intentioned critics.

Guiding Principles for Cyber Risk Governance: Principles for Directors in Overseeing Cybersecurity

The purpose of this document is to provide boards of directors a set of Guiding Principles to enable the implementation of an effective cybersecurity program. A director should understand the full range of cyber risks facing his or her company and encourage management to develop appropriate strategies tailored to the company’s operating environment, risk profile, and long-term goals.

The specific needs of any effective cyber program include careful planning, smart delegation, and a system for monitoring compliance — all of which directors should oversee. It’s no longer a question of whether a company will be attacked but more a question of when this will happen — and how the organization is going to prevent it. Smart network surveillance, early warning indicators, multiple layers of defense, and lessons from past events are all critical components of true cyber resilience. When things go wrong, whether in a major or minor way, the ability to quickly identify and respond to a problem will determine the company’s ultimate recovery.

Cybersecurity cannot be guaranteed, but a timely and appropriate reaction can.

Longer term, the board should understand and consider the strategic business implications of cybersecurity, foster the right company culture surrounding security, and encourage the integration of cyber risk management practices into other governance and approval processes. In essence, the board should consider cybersecurity as a managerial issue, not just as a technical one.

Click here for the full report.

House Subcommittee Considers Potential for Central Bank Digital Currencies

The House Financial Services Subcommittee on Monetary Policy and Trade considered testimony on the future of cryptocurrencies, including the potential development of central bank digital currencies (“CBDCs”).

The following witnesses testified at the hearing: Dr. Rodney J. Garratt, Professor of Economics at the University of California in Santa Barbara, Dr. Norbert J. Michel, Director of the Heritage Foundation Center for Data Analysis, Dr. Eswar S. Prasad, the Nandlal P. Tolani Senior Professor of Trade Policy at Cornell University, and Mr. Alex J. Pollock, Distinguished Senior Fellow at the R Street Institute.

Dr. Garratt noted the increased prevalence of electronic payment systems and resulting decline in the use of cash for payments. He suggested the possibility of developing a “widely accessible, retail-oriented [CBDC] that could be used by the public for person-to-person and retail transactions.” Dr. Garratt acknowledged the various risks associated with such an undertaking, and asserted that further research will be necessary to better understand the monety policy and financial stability issues.

Dr. Michel explained that paper-based payments have faded in popularity. He encouraged the “neutral” treatment of all forms of currency, including cryptocurrency, and asserted that capital gains taxes should not apply to cryptocurrency transactions. Dr. Michel argued against both the development of CBDCs and restrictive policies that may limit the development and growth of private cryptocurrencies, and applications of distributed ledger technology.

Mr. Pollock warned of the dangers of CBDCs. He cautioned that CBDCs could potentially result in an “increase of the monopoly power of central banks.”

Dr. Prasad also warned of the potential effects of CBDCs on traditional banking structures.

President Trump Issues Executive Order to Establish Task Force on Market Integrity and Consumer Fraud

President Donald J. Trump issued an Executive Order instructing the Attorney General (“AG”) to establish a Task Force on Market Integrity and Consumer Fraud (the “Task Force”). The goal of the Task Force is to provide guidance on financial fraud and other crimes, including cyber fraud, that target members of the public.

Specifically, the Task Force will give recommendations to the AG on fraud enforcement activities across the DOJ regarding (i) actions to improve inter-agency cooperation in investigating and prosecuting financial crimes, (ii) actions to bolster communication among Federal, State, local and tribal authorities with respect to the detection, investigation and prosecution of financial crimes, and (iii) changes in “rules, regulations, or policy, or recommendations to . . . Congress regarding legislative measures, to improve the effective investigation and prosecution” of financial crimes.

The Task Force will terminate and replace the Financial Fraud Enforcement Task Force created by Executive Order 13519 on November 17, 2009, which is now revoked.

In remarks delivered in Washington D.C., SEC Chair Jay Clayton expressed support for the establishment of the Task Force. Mr. Clayton reaffirmed the importance of inter-agency cooperation when it comes to protecting retail investors, and underscored some of the actions that the SEC recently undertook to confront retail securities fraud. In particular, Mr. Clayton highlighted retail enforcement strategies, emergency actions, and cyber and initial coin offering (“ICO”) fraud. With respect to retail enforcement strategy, Mr. Clayton discussed the Retail Strategy Task Force created by the SEC in 2017 to provide additional protection for Main Street investors by developing strategies for dealing with various types of wrongdoing that most impact retail investors. Mr. Clayton also stated that in response to bad actors utilizing new technologies to commit ICO fraud, the Enforcement Division created a Cyber Unit to deal specifically with cyber-related crimes.

Lofchie Comment: There seem to be two major differences between the newly issued order and the Executive Order that it replaced.

First, the former Task Force included membership from a complete A-Z of agencies making it unwieldy at best. The reconstituted Task Force can call upon the agency alphabet as is needed.

Second, the former Task Force was established, in large measure, to address concerns related to the financial crisis. The new Task Force is forward-looking; it now includes fraud on the government, cyberfraud, fraud against senior citizens, health care fraud, and fraud involving cryptocurrencies.

Fed Weekly Balance Sheet since 1914 Now Available

With several current or former undergraduate students of CFS Special Counselor Steve Hanke, I have converted the Fed’s weekly balance sheet from its beginning into spreadsheet form. The data should prove useful for anyone concerned with the quantitative study of monetary policy in the United States over the last 100+ years. Our working paper, “The Federal Reserve System’s Weekly Balance Sheet since 1914,” is available here.

The working paper is based on three earlier papers that I have previously written about; all are available at the link above:

“Insights from the Federal Reserve’s Weekly Balance Sheet, 1914-1941” by Justin Chen and Andrew Gibson,” January 2017 (post)

“Insights from the Federal Reserve’s Weekly Balance Sheet, 1942-1975” by Cecilia Bao and Emma Paine, May 2018 (post)

“Insights from the Federal Reserve’s Weekly Balance Sheet, 1976-2017” by Nicholas Fries, July 2018 (post)

CFS Monetary Measures for June 2018

Today we release CFS monetary and financial measures for June 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.8% in June 2018 on a year-over-year basis versus 4.5% in May.

For Monetary and Financial Data Release Report:

For more information about the CFS Divisia indices and the data in Excel:

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

The Fed’s Weekly Balance Sheet since 1976

Students of CFS Special Counselor Steve Hanke have previously written two papers digitizing the weekly balance sheet of the Federal Reserve System from 1914-1941 and 1942-1975 and analyzing developments in the Fed’s balance sheet. I wrote about them in previous posts. Now a third paper completes the data and the analysis by bringing the story up to the present. The author is Nicholas Fries and the paper is called “Insights from the Federal Reserve’s Weekly Balance Sheet, 1976-2017.”

The most recent paper is no. 114 (currently the latest paper) in this working paper series that Hanke edits. The earlier papers were nos. 70 and 104 in the series. The data files can be viewed from links under the paper.

The Fed has made digitized weekly data of its weekly balance sheet available since 1996, but not earlier, and from 1996-2002 the data were only previously available as individual files on the Fed’s Web site, not in a spreadsheet. From 2002 downloadable spreadsheet data are available. Besides appreciating the service Fries has done making the data available, readers will appreciate his balance sheet analysis, which is simple and to the point.

One more paper is left in the series on the Fed’s balance sheet. I will post about it within the next month.