Keynote Address of Commissioner Kristin Johnson at UC Berkeley Law Crypto Regulation Virtual Conference
Post Crypto-Crises: Pathways for Protecting Customers and Preserving Market Integrity
February 08, 2023
Expanding Existing Investors Protections
In June 2022, the CFTC filed a civil enforcement action against Cornelius Johannes Steynberg, a citizen of South Africa and his company, Mirror Trading International Proprietary Limited or MTI (“MTI”), for operating a $1.7 billion Ponzi scheme that solicited Bitcoin investments. MTI lured investors into the scam by explaining to investors that they could deposit their Bitcoin into a commodity pool to trade foreign currency on a leveraged or margined basis off-exchange through a proprietary “bot.” MTI claimed to have engaged in profitable trades and reported only a single day of trading losses. In reality, however, MTI never profitably traded forex. In fact, MTI simply converted new investors deposits into purported “profits” for existing customers.
At the time of the Enforcement Division’s announcement, I explained that “fraudsters often take full advantage of new technology, global connectivity, and perceived lack of a cop on the beat to perpetrate their scams.”
MTI claimed to be a registered commodity pool operator (“CPO”) but had never registered, in accordance with statutory and regulatory guidance, with the National Futures Association (NFA). To better understand the implications of this case, it merits quickly considering the CFTC oversight of commodity trading advisors (“CTA”s) and the role of CPOs and CPAs as well as the limitations of customer protections that impose fiduciary liability.
The CFTC has long acknowledged—and in various enforcement and administrative actions asserted—that a fiduciary relationship may exist between Commission intermediaries (futures commission merchants (FCMs), introducing brokers (IBs), CTAs, and CPOs) and their customers.
While the SEC has codified this standard of care, the Commission has not yet codified a standard of care. Currently, unless an investor asserts a claim of fraud under Section 4b of the Commodity Exchange Act (“CEA”), claims asserting breaches of CPO and CTA duties are unlikely to be successful. A reparations case that jurisprudentially punches above its weight illustrates these concerns.
In January 2016, Daniel Emily filed a claim initiating a reparations proceeding against Guy Gleichmann and his company United Strategic Investors Group, LLC (“USIG”) alleging unauthorized trading and churning in violation of the CEA. After a hearing on the merits in 2016, the administrative judge issued an initial decision on May 23, 2017, dismissing the unauthorized trading claim, but finding that Gleichmann had engaged in churning (excessive trading in the assets in Emily’s account) and awarded damages. Gleichmann appealed the initial decision to the Commission. In October 2017, after a review of the appeal, the Commission remanded the case for further findings.
Upon consideration of the evidence and analysis of the relevant law, the administrative judge found that Emily failed to present evidence of churning. Emily then appealed on the grounds that the same alleged churning conduct gave rise to claim that Gleichman breached his fiduciary duties to Emily.
The Commission, in its opinion, acknowledged that a relationship between a CTA and her customer may give rise to a fiduciary duty. The Commission found, however, that a fiduciary duty claim alone was insufficient— “[t]he only torts that can result in a reparations award are those wrongs that also constitute violations of the Act or the Commission’s rules, regulations or orders.” The decision reflects something of a challenge for customers and indicates an area of our regulation that may benefit from greater clarity. A demographic shift toward increasing numbers of retail investors engaging in complex crypto-derivatives transactions brings these concerns regarding the duties of intermediaries sharply into focus.
While Emily did not involve a digital assets claim, coupled with the MTI case, we can see a critical gap in customer protection in an area that merits careful consideration. What types of claims will digital asset investors who rely on existing intermediaries have in our markets? Should these protections be enhanced or duties heightened in light of the risks of crypto investing?
Fiduciary obligations may arise when Commission registrants provide investment advice. The Commission sets out a CTA’s obligations to its customers under in Part 4 of the Commission’s rules. Instead of introducing fiduciary obligations to protect customers from fraud claims under the CEA, the CFTC has adopted disclosure requirements for CTAs that focus on providing clients information about fees and potential conflicts of interest; performance information; risk disclosure statements; regulatory filings; and marketing materials.
All of these provisions are rightly designed to ensure that clients and potential clients receive the information they need to make informed investment decisions. In the context of digital assets, as an emerging asset class with tremendous risk, I believe that we may need to do more to protect customers. Fiduciary-based customer protections that target information asymmetries are not but can be part of the current digital assets regulatory dialogue. In my role as a Commissioner, I intend to make that happen.
I believe that it is worth considering a heightened duty for CTA and CPOs who offer crypto investing advice. I have also advocated for inclusion of a provision in crypto legislation that would extend the application of reparations jurisdiction to protect crypto commodity derivatives customers. We need to ensure that all customers benefit from the protections of the reparations program.
Putting my words into action, I intend to introduce a process for necessary preliminary dialogues and potential recommendations to close these gaps through my service as sponsor of the Commission’s Market Risk Advisory Committee (“MRAC”), and in the coming months will be further developing and overseeing the work of three MRAC subcommittees: the Future of Finance, Market Structure, and CCP Risk and Governance subcommittees. My intention is to leverage the expertise we’ve gathered within MRAC and its subcommittees to tackle these tough issues through detailed reports with policy recommendations and proposed regulatory text that could facilitate the Commission’s work. Now is the time to act and I intend to do all that I can to facilitate Commission’s work.
Thank you for allowing me to join you to share a few cautionary tales and lessons from the recent crypto-crises.
 Tiffany Hsu, All Those Celebrities Pushing Crypto Are Not So Vocal Now, New York Times, May 17, 2022. For examples of advertisements soliciting customer investments in cryptocurrencies or related products, see Crypto.com, Fortune Favors the Brave (2021), available at Crypto.com Commercial Super Bowl 2021/2022 - YouTube; West Realm Shires Services Inc. dba “FTX US”, Don’t Be Like Larry: Don’t Miss Out on Crypto, NFTs, the Next Big Thing (2022), available at FTX Super Bowl Don't miss out with Larry David - YouTube. There are ongoing investigations by federal and state authorities. See, e.g., SEC, Release No. 2022–183, SEC Charges Kim Kardashian for Unlawfully Touting Crypto Security, Oct. 3, 2022, https://www.sec.gov/news/press-release/2022-183 N.Y. Att’y Gen., Attorney General James Sues Cryptocurrency Platform for Operating Illegally and Defrauding Investors, Sept. 26, 2022, https://ag.ny.gov/press-release/2022/attorney-general-james-sues-cryptocurrency-platform-operating-illegally-and (announcing lawsuit filed by NY and seven state securities regulators against cryptocurrency companies Nexo Inc. and Nexo Capital Inc. for failing to register and misrepresenting registration status).
 See e.g., Ch. 15 Petition, In re Three Arrows Capital, Ltd., No. 1:22-BK-10920 (Bankr. S.D.N.Y. July 1, 2022); Ch. 11 Petition, In re Voyager Digital Holdings Inc., No. 1:22-BK-10943 (Bankr. S.D.N.Y. July 5, 2022); Ch. 11 Petition, In re Celsius Network LLC, No. 1:22-BK-10964 (Bankr. S.D.N.Y. July 13, 2022).Inearly November, FTX and BlockFi joined the list of crypto-firms seeking bankruptcy protection. Ch. 11 Petition, In re BlockFi Inc., No. 3:22-BK-19361 (Bankr. D.N.J. Nov. 28, 2023); Ch. 11 Petition, In re FTXTrading Ltd., No. 1:22-BK-11068 (Bankr. D. Del. Nov. 11, 2022). The list continues to grow—just last month, the crypto lending units of Genesis filed for bankruptcy. Ch. 11 Petition, In re Genesis Global Holdco LLC, No. 1:23-BK-10063 (Bankr. S.D.N.Y. Jan. 19, 2023).
 See e.g., Digital Commodities Consumer Protection Act, S. 4760, 117th Cong. (2022); Lummis-Gillibrand Responsible Financial Innovation Act, S. 4356, 117th Cong. (2022); Digital Commodity Exchange Act, H.R. 7614, 117th Cong. (2022). States have proposed some innovative frameworks, most notably New York’s BitLicense. See, e.g., N.Y. Dep’t Fin. Servs., Virtual Currency Business Activity, https://www.dfs.ny.gov/virtual_currency_businesses.
 <Cryptocurrency Regulation: How should practitioners and policymakers react?, https://www.law.berkeley.edu/wp-content/uploads/2023/02/Crypto-Conference-AGENDA.pdf.
 See, e.g., SEC v. W.J. Howey Co., 328 U.S. 293 (1946);
In Howey, the Court held that the definition of a security includes an “investment contract” —meaning an investment of money in a common enterprise with an expectation of profit derived from the efforts of others. 328 U.S. at 297–98. The defendants in Howey sold interests in citrus groves to customers, structured as a sale of real estate, but with an accompanying service contract for cultivation and harvest of the citrus. Id. t 295–96. The purchasers could have arranged to service the grove themselves but, in fact, most relied on the efforts of defendants for a return. Id. at 299–300. In articulating the test for an investment contract, the Supreme Court stressed: “Form [is] disregarded for substance and the emphasis [is] placed upon economic reality.” Id.
 Kristin Johnson, Decentralized Finance: Regulating Cryptocurrency Exchanges, 62 William & Mary L. Rev. 1911 (2021).
 See CFTC Commissioner Kristin N. Johnson, Investing in Investor Protection, Federal Reserve of Chicago Financial Markets Group Fall Conference (Nov. 16, 2023); see also Nahiomy Alvarez, Nomaan Chandiwalla, Alessandro Cocco, 2022 Financial Markets Group Fall Conference–Recap, https://www.chicagofed.org/publications/blogs/chicago-fed-insights/2023/2022-fmg-fall-conference-recap (Feb. 6, 2023).
 See CFTC Commissioner Kristin N. Johnson, Mitigating Crypto-Crises: Applying Lessons Learned in Governance, Risk Management, and Compliance, Digital Assets @ Duke Conference, Duke’s Pratt School of Engineering and Duke Financial Economics Center (Jan. 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2.
 Compl., CFTC v. Bankman-Fried, No. 22-cv-10503-PKC (S.D.N.Y. Dec. 13, 2022), ECF No. 1; Ch. 11 Petition, In re FTX Trading Ltd., No. 1:22-BK-11068 (Bankr. D. Del. Nov. 11, 2022), ECF No. 1.
> Compl., CFTC v. Mirror Trading Int’l Proprietary Ltd., No. 1:22-cv-00635 (W.D. Tex. June 30, 2022), ECF No. 1.
 Kristin N. Johnson, Senate Testimony Before United States Senate Agriculture, Nutrition and Forestry Committee, Mar. 2, 2022, https://www.agriculture.senate.gov/download/testimony/johnson_testimony.
 OTPP, Teachers’ Innovation Platform becomes Teachers’ Venture Growth as part of ambitious growth plan, Apr. 19, 2022, https://www.otpp.com/en-ca/about-us/news-and-insights/2022/teachers--innovation-platform-becomes-teachers--venture-growth-a/.
 OTPP, Ontario Teachers’ statement on FTX, Nov. 17, 2022, https://www.otpp.com/en-ca/about-us/news-and-insights/2022/ontario-teachers--statement-on-ftx/.
 See supra n. 2.
See CFTC, Release No. 8549–22, CFTC Charges South African Pool Operator and CEO with $1.7 Billion Fraud Involving Bitcoin, June 30, 2022, https://www.cftc.gov/PressRoom/PressReleases/8549-22.
 Statement of Commissioner Kristin Johnson Regarding the CFTC Charging South African Commodity Pool Operator and CEO with $1.7 Billion Fraud Involving Bitcoin, June 30, 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement063022b.
 7 U.S.C. § 6b.
 The CFTC’s Reparations Program, administered through the Office of Proceedings, provides an inexpensive, expeditious, and fair forum to resolve disputes between derivatives customers and registered trading professionals. The Commission has permitted reparations proceedings when customers allege, among other claims, fraud (cheating or attempting to cheat customers through fraudulent representations concerning the likelihood of profit or loss; false or misleading statements about trading or about a salesperson, advisor, or the trading program; or false or misleading statements about any other material fact that a customer relies on in making a decision about futures or options trading; nondisclosure (failure to inform customers of the risks associated with futures and option trading; failure to disclose any other material fact a customer may require to make a decision about futures or option trading; breach of fiduciary duty (a failure by a broker or salesperson to act with special care in handling your account when required to do so by the Commodity Exchange Act or CFTC rules); unauthorized trading; misappropriation; churning; wrongful liquidation; and failure to supervise. See https://www.cftc.gov/LearnAndProtect/ReparationsProgram/DetermineYourEligibility.
 “[C]hurning occurs when a broker who has control over a customer’s account trades the account excessively for the purpose of generating commissions, without regard to the customer’s interests.” Fields v. Cayman Associates, Ltd., CFTC Nos. R 79-201, 79-355, 1985 WL 56217, at *1 (Jan. 2, 1985). To establish a claim for churning, a party must demonstrate that a trader: (1) controlled the level and frequency of trading in the account, (2) chose an overall volume of trading that was excessive in light of the complainant’s trading objectives, and (3) acted with either intent to defraud or in reckless disregard (scienter) of the customer’s interests. Michael L. Gilbert v. Refco, Inc. and David L. Davis, CFTC No. 87-R223, 1991 WL 127404 at *10 (June 27, 1991).
 Daniel J. Emily v. Guy K. Gleichmann and United Strategic Investors Group, LLC, CFTC No. 14-R007, 2020 WL 3248253 (June 9, 2020).
 Klatt v. Int’l Trading Grp., Ltd., CFTC No. R77-114, 1978 WL 10813, at *3 (June 21, 1978).
 Lee v. Lee, CFTC No. 06-R054, 2007 WL 776613, at *5 (Mar. 13, 2007).
 See CFTC & SEC, A Joint Report of the SEC and the CFTC on Harmonization of Regulation, Oct. 16, 2009, at 68, https://www.sec.gov/news/press/2009/cftcjointreport101609.pdf. A remedy for breach of fiduciary duty may exist under state law where the common law imposes fiduciary duties on professionals, like CTAs, who make trading decisions on behalf of others. In his concurring statement in Emily, former Commissioner Dan Berkovitz recognized that customers in the derivatives industry would benefit from a uniform standard of conduct
 See Subparts B and C of Part 4 of the Commission’s regulations. 17 C.F.R. Part 4.
 The Commission’s advisory committees are policy incubators that foster effective collaboration among market participants with divergent views and produce work product has historically served as the foundation for Commission policy and proposed regulations. See, e.g., CFTC, Market Risk Advisory Committee, https://www.cftc.gov/About/AdvisoryCommittees/MRAC.