Thank you, Frank [Partnoy], Robert [Bishop], and Gina-Gail [Fletcher] for the kind invitation to join you today.  I would also like to extend my sincere thanks to the Berkeley Center for Law and Business, Berkeley Center for Responsible, Decentralized Intelligence, and International Institute of Law and Finance.  An anticipated disclaimer, the remarks that I will share today reflect my views and not those of my fellow CFTC Commissioners or staff.

Marked by rapid development and an increasingly global distribution, projects at the intersection of finance and technology (fintech) have spurred passionate debate.  The exponential growth of cryptocurrencies and a broader ecosystem of digital asset projects punctuates this debate.

Last year, Madison Avenue-styled Superbowl ads, music videos, and elaborate social media campaigns endorsing cryptocurrencies reached a fever pitch, as Hollywood celebrities and revered athletes—the “influencers”—touted cryptocurrency as the essence of “hip culture” and the pathway to financial inclusion.[1]  The ads, however, failed to mention that the crypto market was in the middle of a meltdown and failed to include the oldest and most universal disclaimer, “buyer beware.” Coupled with the cascade of liquidity and solvency crises at crypto-firms last year,[2] a gap in the oversight of crypto-spot markets has amplified calls for Congressional intervention. Thoughtful legislative and regulatory solutions offer diverse solutions, reflecting the complexities of the digital assets and the crypto-ecosystem.[3]  Consequently, today’s conference is, simply stated, timely.

The insightful title for today’s program—Cryptocurrency Regulation: How Should Practitioners and Policymakers React?—underscores two central issues.[4]  First, there is increasingly a general acknowledgement that it is now time to begin to craft careful, well-tailored regulations and introduce seasoned regulatory oversight in cryptocurrency markets.  Second, the conference title invokes a charge, inviting specific, detailed policy solutions from regulators and other stakeholders. Well, let me share that is a privilege and a pleasure for me to join the highly esteemed participants at today’s conference and to begin to sort out how we [Howey] [5] might proceed.

So, let’s dig in. Over the last several years, I have advocated for the introduction of regulation in cryptocurrency markets.[6]  Over the last few months, in my current role, I began to encourage the Commission to consider several important regulatory measures that do not require Congressional action. Instead, Commission authority enables real-time intervention.

During a keynote speech at the Federal Reserve Bank of Chicago Financial Markets Group Fall Conference hosted only one week after FTX announced plans to enter bankruptcy proceedings,[7] I proposed solutions to address the lack of parallelism in consumer protections available in intermediated and non-intermediated derivatives markets.  I encouraged the Commission to consider initiating a notice and comment rulemaking process to evaluate the need for regulation mandating segregation of customer funds, treatment of customer funds, and the introduction of financial resource requirements for certain derivatives clearing organizations.  During a more recent speech at Duke University, I advanced suggestions regarding corporate governance, risk management, and compliance reforms that include, among other proposals, calls for effective auditing, internal controls, risk management oversight, and appropriate governance of conflict of interests.[8]  I also called for Congress to consider including in any legislation expanding the CFTC’s authority a provision that enables the Commission to have greater authority including, in the least, a robust dialogue in advance of the acquisition of a controlling equity ownership stake in any registered market participant.[9]

While we await Congressional action, we may advance and inform the regulatory dialogue within the Commission, with our fellow federal and state regulatory agencies, and international regulators in jurisdictions around the world.  Our efforts to understand operational infrastructure, market dynamics, and market participants will enhance our ability to shape the contours of how we envision implemented regulation might protect customers, ensure market integrity and stability, and prevent systemic risk.

Looking across the regulatory landscape, the crypto-crises that began in late last spring reveal important lessons for regulators.  In particular, we might turn our attention to investors in crypto asset funds and the intermediaries that facilitate investments.

In preparing for today’s conference and thinking about these two types of intermediaries, I began to keenly focus on two specific events that bookmark the crypto-crises last fall for the Commission.  First, and perhaps more obviously the filing of FTX’s bankruptcy petition and the CFTC’s enforcement action against FTX.[10] Second, an earlier enforcement action against Mirror Trading, a South African commodity pool operator.[11] Each is instructive.

Protecting Investors: Preserving Teachers’ Pensions

During a nomination hearing before the United States Senate Agriculture, Nutrition and Forestry Committee a little less than a year ago, I shared with Members that my family migrated to the Midwest in the early 1800s and settled in a small town on the Wabash River.[12]  In our recorded family history over the last two hundred years, many in my family developed small businesses, volunteered to serve in the armed forces, and worked as civil servants, nurses, and healthcare professionals. A few accepted the noblest calling and agreed to serve as teachers.

Reflecting on the lessons that I learned from my family, I observed a few things that animate my remarks today including an exceptional work ethic, thoughtful financial planning, and disciplined savings.  These tools enabled my family to buy homes where they could raise their children, support them through college and early careers, and hopefully, retire with enough to buy a Winnebago.  I completely appreciate that three quarters of this audience will have to Google the term “Winnebago.”

Many who live in the eastern part of Michigan where I was born spend a pretty fair amount of time visiting Canada for plenty of reasons. Maple syrup. Maple Leafs. Carly Rae Jepsen, Justin Bieber, and Drake. We also share values such as supporting those in our communities engaged in public service.

In the aftermath of the crypto-crises that characterized markets last fall, there is one additional point that I want to focus on today.  A heartbreaking revelation that strikes a chord with all of us who are intimately familiar with the critical contributions (in the face of persistent resource constraints) and indefatigable spirit of school teachers.

As FTX lunged toward bankruptcy, rumors circulated regarding the identity of FTX’s customers and investors.  For many Canadian teachers, it must have been devastating to discover that the Ontario Teachers’ Pension Plan (“OTPP”) invested and likely will have lost nearly $100 million in connection with the pension plan’s investment in FTX.

In 2019, leaning into the exciting opportunities in the fintech sector, OTPP launched the Teachers’ Venture Growth platform.[13]  The platform created an opportunity to invest in emerging technology companies raising late-stage venture and growth capital.

In October 2021, OTPP invested $75 million USD in FTX International and its US entity, FTX.US (together “FTX”). In January 2022, OTPP doubled down, increasing its investment in FTX.US by another $20 million USD. On November 11, 2022, FTX filed for bankruptcy.

In a public statement issued a week after FTX filed for bankruptcy, OTPP revealed its investment in FTX.[14] According to OTPP, its interest in FTX represented less than 0.05% of the fund’s total net assets and a 0.4% and 0.5% ownership position in FTX International and FTX.US, respectively.[15]

OTPP’s statement defended the fund’s due diligence efforts, emphasizing the benefits of the fund’s attempts to “diversify investments across asset classes, geography, time horizons, and economic outcomes, to mitigate risk and enhance returns.”[16]  Notwithstanding its defense, there was no way to deny the need to write-down the fund’s $95 million investment in FTX to zero.

For some in this room, OTPP’s investment decision is a cautionary tale. For others currently navigating the challenges of any of the several crypto-firm bankruptcies of 2022 as creditors or investors, it may still feel all-too-soon to comfortably reflect on losses and investment decisions related to portfolio companies.

The Critical Role of Gatekeepers

Carefully examining the consequences of the crypto-crises for investors like OTPP reveals an extensive list of issues that merit consideration for global venture capital funds, public and private pension funds, hedge funds, alternative investment funds, and so many others.

I urge firms engaged in investing in emerging asset classes to continue to adhere to the fundamentals in evaluating early to late stage investments or making decisions regarding portfolio companies.  The fundamentals include actively and aggressively engaging in old school due diligence processes that raise critical questions regarding corporate governance, risk management, and financial disclosures.  I read the OTPP statement as a call for renewed focus on the due diligence processes adopted by funds investing in emerging technologies.  Those engaged in supporting these early stage firms in multiple rounds of capital raising are on the front lines for separating the wheat from the chaff and are often best positioned to detect fraud or misconduct.

What Can We Do Now?

While we continue to learn more about the risk management, corporate governance, and compliance failures that led to FTX’s collapse, there are some deeply concerning details and lessons that should immediately inform the behavior of managers of businesses in the crypto-ecosystem and those deciding to invest in these firms.  How do we determine what behaviors to prohibit, limit, surveil or monitor?  Facing the failures in its investment decision process, the OTPP statement said it best—we must “fully support the efforts of regulators and others to review the risks and causes of failure for this business.”[17]

As a final observation, I read the OTPP’s statement as a call to action for regulators to think carefully and critically about the gaps in our oversight, in order to mitigate the risks and causes of failure illustrated by the events at, not only FTX, but the daisy chain of bankruptcies that populate the timeline of the summer and fall of 2022.  A chain of events that began with or was at least fueled by TerraUSD's plunge below the 1-to-1 peg with the U.S. Dollar followed by the bankruptcies of Three Arrows Capital, Voyager Digital, Celsius Network, FTX, BlockFi, and the most recent firm entangled in the web of the FTX fallout, the cryptocurrency lending affiliate of Genesis Global.[18]

What can we do now?  The Commission should at this moment undertake a substantive and comparative review of the regulatory protections afforded to customer funds, the investment of funds, and the duties of those that guide investments servicing customers in crypto derivatives market.

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.[19]  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.”[20]

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”),[21] 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.[22]  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.[23] 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.[24]

The Commission, in its opinion, acknowledged that a relationship between a CTA and her customer may give rise to a fiduciary duty.[25]  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.”[26]  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.[27]

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.[28]  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.

Conclusion

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.[29]  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.

[1] 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).

[2] 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).

[3] 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.

[4] <Cryptocurrency Regulation: How should practitioners and policymakers react?, https://www.law.berkeley.edu/wp-content/uploads/2023/02/Crypto-Conference-AGENDA.pdf.

[5] 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.

[6] Kristin Johnson, Decentralized Finance: Regulating Cryptocurrency Exchanges, 62 William & Mary L. Rev. 1911 (2021).

[7] 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).

[8] 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.

[9] Id.

[10] 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.

>[11] Compl., CFTC v. Mirror Trading Int’l Proprietary Ltd., No. 1:22-cv-00635 (W.D. Tex. June 30, 2022), ECF No. 1.

[12] 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.

[13] 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/.

[14] 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/.

[15] Id.

[16] Id.

[17] Id.

[18] See supra n. 2.

[19]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.

[20] 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.

[21] 7 U.S.C. § 6b.

[22] 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.

[23] “[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).

[24] Daniel J. Emily v. Guy K. Gleichmann and United Strategic Investors Group, LLC, CFTC No. 14-R007, 2020 WL 3248253 (June 9, 2020).

[25] Klatt v. Int’l Trading Grp., Ltd., CFTC No. R77-114, 1978 WL 10813, at *3 (June 21, 1978).

[26] Lee v. Lee, CFTC No. 06-R054, 2007 WL 776613, at *5 (Mar. 13, 2007).

[27] 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

[28] See Subparts B and C of Part 4 of the Commission’s regulations.  17 C.F.R. Part 4.

[29] 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.