New York’s State attorney general has wide latitude to investigate a foreign entity like iFinex, said a NY appeals court.
A New York State appeals court affirmed on July 9 that the state attorney general’s fraud investigation into iFinex et al. — i.e., iFinex, Bitfinex and Tether Holdings — could continue. Whether that probe will result in litigation against the company that issues Tether (USDT), the world’s most widely used stablecoin, is anyone’s guess, but if it does, it might promote a more regulated stablecoin industry.
As Felix Shipkevich, an attorney specializing in cryptocurrency-related legal and regulatory matters at Shipkevich PLLC, told Cointelegraph: “The New York attorney general, NYAG, is often viewed as the nation’s most important state enforcer of financial laws.” He added:
“The recent New York Appellate Court’s decision expanding the NYAG’s broad investigatory powers under the Martin Act is a significant precedent for New York and beyond. This means that the stablecoin issuers have been warned that NYAG under the Martin Act has the power to investigate your stablecoin issuance efforts.”
Kayvan Sadeghi, a partner at law firm Schiff Hardin, agreed that the court decision affirmed the NYAG’s expansive authority to prosecute securities and commodities fraud under the Martin Act, telling Cointelegraph:
“The court held that the attorney general has wide latitude to investigate a foreign entity if she ‘has a reasonable basis for believing that [it] has violated a New York statute,’ and the AG faces a low bar to make only a ‘sufficient start’ in demonstrating the existence of personal jurisdiction and that burden ‘requires a far lighter showing’ for an investigation than is required to bring a lawsuit.”
Bitfinex bars U.S. customers
Because it doesn’t even serve customers in the state of New York, iFinex has argued that the NYAG’s case against it should be dismissed. Bitfinex’s terms of service specifically barred customers from New York in January 2017, individual United States customers in August 2017 and “entity” U.S. customers in August 2018.
The key takeaway, according to Sadeghi, is that if you have enough connection to New York to come to the attention of the New York attorneys general, then “you will have a hard time arguing that you are outside the reach of her investigatory authority. Anyone who thinks they have taken steps to avoid New York may want to reevaluate with experienced enforcement counsel.”
Apropos of the July 9 court order in Letitia James v. iFinex Inc., et al., Stuart Hoegner, the general counsel at Bitfinex, told Cointelegraph in a statement: “We have read the decision issued today by the Appellate Division of the New York Supreme Court, First Department. As we have at all times in this process, we will respect the court’s order. We have no further comment on this matter at this time.”
$850 million has been lost
Many traditional banks won’t touch unregulated or off-shore companies dealing in digital currency, and so in 2014, iFinex, headquartered in Hong Kong and registered in the British Virgin Islands, used a third-party foreign entity to process customer deposits and withdrawals, according to the July 9 court document. But somewhere around mid-2018, as the NYAG later learned, “this entity had refused to provide iFinex with close to $1 billion of their commingled client and corporate funds.” It’s since been widely reported that $850 million has been lost.
Tether Holdings had represented to the NYAG “that every tether is ‘backed’ by one U.S. dollar, and any holder of tether may redeem it for one U.S. dollar at any time.” Later, iFinex changed its representation — declaring on its website that each Tether “is backed by Tether Holding’s ‘reserves,’ which include unspecified currency, ‘cash equivalents,’ and ‘other assets and receivables from loans made by Tether [Holdings] to third parties,’ including to affiliated entities,” as noted in the court document. The company seemed to be moving around money among affiliates, too, and as the NYAG learned in February 2019, “iFinex was planning to take a $900 million line of credit from Tether Holdings.”
The NYAG was concerned that this last action “indicated that iFinex was in serious financial trouble, that Tether Holdings’ cash reserves backing tether would be dissipated, and that respondents had misled their customers in relation to these events.”
The NYAG, therefore, sought and received an order from the court requiring iFinex to produce additional documents and also to keep its hands off U.S. dollar reserves held by Tether Holdings. The state Supreme Court issued this order on April 24, 2019, and iFinex moved to overturn it. Finally, on July 9, the appeals court affirmed the Supreme Court’s order.
Potential trouble for other stablecoin issuers
Another stablecoin issuer told Cointelegraph off the record that their firm had been concerned that the appeals court might rule that the NYAG has authority over Bitfinex because Tether constitutes a security under the Martin Act. That might, in turn, influence how the Securities and Exchange Commission views the stablecoin, inviting further stablecoin regulation in the greater United States. That did not happen, to the issuer’s relief.
Sadeghi agreed that the court did not reach the issue of whether Tether was also a security. “Unlike federal law, New York’s Martin Act governs both commodities and securities. So, the distinction was less relevant for purposes of whether the Attorney General could investigate.” Nevertheless, the stablecoin-issuing firm said the appeals court’s ruling is still “potentially troublesome to other stablecoins that operate in New York.”
“No different from any other fraud case”
Not all agree that this court decision is significant. Aviya Arika, the chief of blockchain at Aviya Law, told Cointelegraph that she didn’t think the case would have much lasting impact on the stablecoin sector specifically or the blockchain industry in general. “This case is no different than any other fraud case, whether in blockchain or elsewhere.” The company is alleged to have told its users/investors that it held certain reserves — when it didn’t. That would be considered fraud, but even then: “I don’t see how that projects onto the future of blockchain. It just concerns the misconduct of one [company’s] management or team.”
The New York attorney general’s office has been a stepping stone to higher political office in the past, and pursuing malfeasance among the rich and powerful isn’t a bad way to get noticed by the general populace. As Shipkevich told Cointelegraph: “We have seen significant financial enforcement powers flexed going back to Eliot Spitzer — it catapulted him to become NY’s governor. Here, Letitia James is trying to do the same by flexing her jurisdictional powers over cryptocurrencies — and stablecoins — on the state level.” This might partly explain the AG’s doggedness in prosecuting iFinex.
As for the market impact of the court order, no one contacted by Cointelegraph expected any panicked selling of USDT or other immediate repercussions. As Gregory Klumov, the CEO of Stasis, which issues the Stasis Euro (EURS) stablecoin, told Cointelegraph:
“Panic selling of USDT will happen [only] when the company behind it starts losing assets. Nobody knows what Tether is collateralized with currently — is it cash or crypto, and in what proportions, and how much is accessible to them now. Once the market realizes that there are not enough chairs in the room, when the music stops, everybody will rush to an exit. However, it has to come from prosecutors taking over custody accounts of whatever Tether holds to back their tokens.”
The court order and NYAG investigation may put some stablecoin issuers on notice, however, Arika allowed. Firms acting as custodians for other people’s money or companies issuing electronic money must have financial licenses, she said — which is not the norm in most parts of the world. “This case may drive the regulated stablecoin industry forward.” The NYAG’s pursuit of Tether might encourage other entrepreneurs to embrace regulation — so the same fate doesn’t befall them.
What if the NYAG’s action goes so far as to bring Tether down? Wouldn’t that potentially taint the entire stablecoin sector, to say nothing of the larger crypto industry?
The problem with Tether is that there is no transparency with its reserves, answered Klumov. If it turns out that the stablecoin is not backed by fiat currency, and Tether were to go down, “then there might be a massive liquidation in crypto assets in all parts of the world. If anything happens to Tether, one should stay away from the cryptocurrencies for a while.” All told, this remains a case to watch, Sadeghi told Cointelegraph:
“If this case proceeds to litigation, it will raise a host of novel issues likely to guide crypto enforcement in New York for years. That said, investigations like this very often settle before a case is brought. Either way, the crypto industry should keep a close eye on the New York AG, along with the New York Department of Financial Services, to understand the state’s evolving approach to the crypto industry.”