UK: Commodity Exchange Act Liability For Smart Contract Coders

The Commodity Futures Trading Commission (CFTC) is considering how smart contract applications on the blockchain implicate its jurisdiction and enforcement authority. Smart contracts are pieces of code on a blockchain that execute certain steps (such as moving a cryptocurrency from one wallet to another) when a condition or set of conditions is met. They are not "contracts" in the traditional legal sense, nor are they "smart" in the sense of using artificial intelligence or similar technologies.

In October 2018, CFTC Commissioner Brian Quintenz discussed at the GITEX Technology Week Conference how the existing Commodity Exchange Act (CEA) regulatory framework may apply to this new technology. If the CFTC determines that smart contracts that execute on a blockchain facilitate trading in off-exchange futures, swaps with retail customers or event contracts the agency deems contrary to the public interest, how will it approach enforcement? While Quintenz addressed this question in hypothetical terms, it is clear that applying the CEA to potential trading applications on a blockchain will require the CFTC to expand its focus to smart contracts. In doing so, the CFTC will need to consider how to adapt a preexisting regulatory scheme to new technology—in this case, a technology whose decentralized structure is fundamentally different from the structure of intermediation—exchanges, brokers and advisors—on which the CEA is based.

Commissioner Quintenz focused on smart contracts that resemble products that the CFTC regulates or that provide functionality that would permit or facilitate trading of those products. He observed that the execution undertaken by many smart contracts may not comply with the CEA and CFTC rules. If so, who would bear legal responsibility? Quintenz suggested that while certain actors, including developers of the underlying blockchain platform or those who validate transactions, such as miners, do play a role, the developers of the smart contract code could also be held accountable, at least where they "could reasonably foresee, at the time they created the code, that it would likely be used by U.S. persons in a manner that violates CFTC regulations."

Commissioner Quintenz's remarks contemplate a novel use of a longstanding form of liability: that the CFTC could prosecute smart contract code developers for aiding and abetting violations of the CEA and CFTC rules by others, such as smart contract users who engage in unlawful off-exchange transactions, based on protocols created by the smart contract code developers. The CFTC may take the view that the coder aided and abetted the actual users of the smart contract, who would be the primary violators. In practice, it may prove difficult for the CFTC to prevail on this theory when the smart contract at issue is executed on a public permissionless blockchain. In this context, the CFTC may face challenges—i.e., proving a primary violation and the aider and abettor's intent—that are easier to address in typical aiding and abetting cases.

Aiding and Abetting Liability under the CEA

CEA Section 13(a) provides that "[a]ny person who ... willfully aids, abets, counsels, commands, induces, or procures the commission of, a violation of [the CEA or CFTC rules] ... may be held responsible for such violation as a principal." It is settled that the CFTC must establish three elements to prove aiding and abetting liability: "(1) the CEA was violated, (2) the aider and abettor had knowledge of the wrongdoing underlying the violation, and (3) the aider and abettor intentionally assisted the primary wrongdoer." With respect to the second prong, while the aider and abettor must have "actual knowledge of the primary wrongdoer's conduct," the CFTC maintains that the aider and abettor does not necessarily need to know that this conduct is unlawful. Moreover, with respect to the third prong, [the CFTC has found that "[k]nowing assistance can be inferred from the surrounding facts and circumstances." The CFTC has said that "[i]ntentional assistance is demonstrated if the aider and abettor 'knowingly participate[s] in the [unlawful] venture and seek[s] by his actions to make it succeed.'"

In a typical aiding and abetting case, the CFTC identifies one or more primary wrongdoers, often by name, and charges them for the primary conduct underlying an aiding and abetting violation. In the CFTC's prior actions, the primary violator typically has a direct or special relationship with the aider and abettor. This direct relationship facilitates the CFTC's ability to prove the aider and abettor's knowledge of wrongdoing and intent to assist. For example, in Brenner v. CFTC, the Seventh Circuit affirmed the Commission's findings of liability against a woman for aiding and abetting her husband's CEA violations by knowingly assisting him in opening accounts and trading in her name. The court cited testimony from an employee of a trading firm whose discussions with the couple led him to believe that the wife was aware that her husband was trading on her account. Another prominent example is CFTC v. MF Global Holdings Ltd., where the U.S. District Court for the Southern District of New York found that the assistant treasurer of MF Global's Treasury Department aided and abetted the firm's customer fund-segregation violations by directing, approving or causing transfers of funds from customer segregated accounts to firm proprietary accounts, "knowing" that the customer-segregated funds would be transferred to proprietary accounts. Other cases illustrating the special relationship between the primary violator and the aider and abettor have involved:

  • A firm aiding and abetting a customer's concealment of material facts from an exchange by failing to report a trade until after the close of trading.
  • An associated person of a futures commission merchant aiding and abetting a colleague's fraudulent solicitations by creating a false audit of trading results, helping to pay for the distribution of a fraudulent email and making misrepresentations in meetings with prospective investors.
  • A firm's controller aiding and abetting the firm's regulatory violations by failing to notify the CFTC promptly upon detecting a shortfall in certain customer accounts, and ordering a subordinate to transfer money from the firm's own account to its customer segregated account.
  • A broker aiding and abetting unlawful disclosures of customer information by soliciting exchange employees for the information, and providing them with information needed to identify the data that he sought.

Even in the absence of a direct or special relationship, the CFTC has often cited specific facts—such as direct communication between the primary violator and the aider and abettor—to demonstrate that the two parties acted in a coordinated manner. For instance, the CFTC has found aiding and abetting violations where traders at different banks allegedly coordinated to manipulate benchmark rates and other financial instruments, frequently pointing to specific communications between them, such as messages in private chat rooms, to support the agency's findings.

To view the full article, please click here

Originally published in Harvard Law School Forum on Corporate Governance and Financial Regulation

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