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New York regulator’s conflict with fintech firm spills into view

Tensions grow over enforcing rules designed for traditional financial institutions

New York state regulators in April denied applications by Bittrex for licenses to run a virtual currency business and to engage in money transmission activity. (Dan Kitwood/Getty Images file photo)

The battle over the benefits and risks of new financial technology is escalating, in the form of a dust-up between New York state and a Seattle-based virtual currency business that, to the surprise of fintech followers, took the fight public.

The disagreement between regulators at the New York Department of Financial Services and Bittrex Inc., a cryptocurrency exchange, highlights the growing tension between fintech innovators and regulators enforcing rules designed for older, traditional financial institutions.

To at least one lawyer, the case signals a need to establish a single federal regulator of cryptocurrency exchanges.

New York in April denied applications by Bittrex for licenses to run a virtual currency business and to engage in money transmission activity. It also ordered Bittrex, which has been operating in the state since 2015, to stop doing business in New York. Regulators referred to “deficiencies” in Bittrex’s anti-money laundering and bank secrecy compliance, saying they led to a large number of transactions being processed for customers in countries targeted by U.S. economic sanctions, including Iran and North Korea.

Bittrex quickly and publicly replied, saying it “adamantly” disagreed with the department’s claims and allegations that the company said contained numerous factual inaccuracies. Bittrex said it “never had” any North Korean customers and that Iranian customers had been reported to the U.S. Treasury Department’s Office of Foreign Assets Control. The company said that it maintained a risk assessment framework that had been approved by outside counsel and that it fully trains all employees in anti-money laundering policies and procedures.

The state followed up several days later with an article in Coindesk — a digital media organization covering the crypto asset and blockchain technology community — challenging Bittrex’s version of the application process, saying the firm was misstating facts and presenting “a misleading picture about the denial.”

The regulators’ level of detail surprised New York financial services lawyer Gary DeWaal of the law firm Katten Muchin Rosenman LLP, which doesn’t represent a party in the matter. He told CQ Roll Call that the regulators’ letter read more like the findings of an enforcement action than of a simple license rejection.

DeWaal, a former senior trial lawyer with the Commodity Futures Trading Commission, said he was surprised that the state agency published a press release announcing the decision against Bittrex. He called the regulators’ article “totally unprecedented” in his 40 years of practicing law.

DeWaal described the exchange as an “extraordinary public brawl” akin to the type of back-and-forth between adversaries in a litigation setting rather than a license application. New York’s “public denial of Bittrex’s license with explanations transformed what should be private interactions into public theater,” he told CQ Roll Call.

Call for federal regulator

DeWaal’s conclusion was that “the case for a single federal regulator of cryptocurrency is overwhelming.” He bemoaned the multitude of federal and state regulators that assert jurisdiction over cryptocurrency exchanges. “To me, this hodgepodge approach is a big problem waiting to happen and creates a too-high barrier to entry for legitimate firms that wish to provide innovative crypto asset trading solutions.”

Bittrex has been engaged in the virtual currency business in New York under a safe harbor since 2015 while the state reviewed its license to run a virtual currency business. It applied for the money transmission license in July 2018.

In addition to the allegations about money laundering and bank secrecy, the regulators took Bittrex to task for a “lack of adequate due diligence” in launching tokens and products on its exchange and in identifying customers.

“For example, in some cases where the token applicants had refused to complete their applications — and in one case where there was no trade application at all — the tokens were nevertheless accepted for trading and allowed to trade,” Daniel Sangeap, a DFS deputy superintendent and deputy counsel, wrote  in a four-and-a-half page letter to Bittrex CEO Bill Shihara.

State examiners also found that “a substantial number of aliases” — including “Elvis Presley” and “Donald Duck,” and “obscene terms and phrases” — were used in identifying accounts at Bittrex, according to the letter. It also said Bittrex had indicated an unwillingness to comply with requirements to keep a certain amount of capital on hand.

Bittrex said the state’s actions “show that it was focused on retribution, rather than consumer protection. … In addition, the personal and vindictive nature of the NY DFS’s actions is apparent and it, unfortunately, will only hurt the ability of New York consumers to leverage the benefits of blockchain technologies.”

“By attacking a small company that applied in good faith for a license from DFS, DFS has demonstrated that companies should be wary about sharing information with them,” Bittrex said.

The company scoffed at the state capital requirements, saying they were “far in excess of that of any other state.” It complained that it hadn’t been provided an opportunity to see or comment on the DFS findings before they were made public.

The fintech firm said it had “respectfully but vigorously challenged DFS’ attempts to apply traditional bank-centric regulatory rules to an entirely different model.”

The article in Coindesk, by New York’s Executive Deputy Superintendent for Banking Shirin Emami, disputed company claims about lack of guidance and time to handle the applications.

“Bittrex either misunderstands or misrepresents the meaning of guidance from a regulator in the context of a license application,” she wrote. “Throughout the application process, Bittrex was repeatedly informed of the regulatory requirements for the licenses it sought and provided with letters describing its deficiencies so the company could address them. Instead, the company spent many rounds of interaction with DFS either promising compliance and failing to deliver it, or trying to persuade DFS that, unlike our other regulated firms, it did not have to comply.”

“Bittrex’s grossly inadequate transaction monitoring system is exacerbated by an additional deficiency: incomplete or missing customer identity data,” Emami wrote. “Bittrex’s gross lack of compliance has consequences.”

The war of words escalated again with Bittrex releasing a response to Emami’s article, also posted on the Coindesk blog. It accused New York of “overstepping its regulatory authority and changing rules and guidelines on the fly.”

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