Nothing cryptic about it: the new rules in UK crypto regulation and their impact on asset recovery

On 7 September 2023, the Financial Conduct Authority (‘FCA’) published a press release setting out its expectations ahead of new crypto marketing rules due to come into force on 8 October.

James Lloyd and Laurence Harris discuss the FCA’s announcement, what incoming rules indicate for future cryptoasset regulation, and the wider implications for those attempting to recover cryptoassets under Part 5 of the Proceeds of Crime Act 2002.

The FCA’s announcement on the increasing regulation of cryptoasset promotions last week marked the latest in a series of messages from the Authority setting out in clear terms its views on cryptoasset practices of recent years. In its announcement, which warns of the new requirements coming into force in October, the Authority is at pains to describe the changes as “tough new rules designed to make the marketing of cryptoasset products clearer and more accurate.” These rules, which follow lengthy consultation, shall implement significant changes to the marketing and advertisement of cryptoassets to UK consumers both by UK-based and offshore firms.

The October 2023 changes

On 8 June 2023, the FCA published Policy Statement PS23/6: Financial promotion rules for cryptoassets. The publication sets out the Authority’s approach to the new rules made by statutory instrument the previous day relating to financial promotion of cryptoassets, creating a new controlled investment (defined as a “qualifying cryptoasset”). Those rules take effect from 8 October 2023.

The rules apply to the financial promotion of cryptoassets within the meaning of Schedule 1 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (‘the FPO’) as inserted by the 2023 statutory instrument, being:

any cryptographically secured digital representation of value or contractual rights that—

a) can be transferred, stored or traded electronically, and
b) uses technology supporting the recording or storage of data (which may include distributed ledger technology);

Most cryptocurrencies and exchange tokens therefore fall in scope, with security tokens caught within the FPO regime already. Notably, however, the rules exclude from their scope:

• Central Bank Digital Currencies (CBDC); and

• Non-fungible tokens (NFTs) – the draft explanatory memorandum to the statutory instrument explained that the “SI is not seeking to bring into scope non-fungible tokens […] as these have so far tended to be used in a way more akin to digital collectibles than financial investments.”

‘Promotion’ under the rules maintains its common definition under s.21(1) Financial Services and Markets Act 2000 (‘FSMA’) by virtue of Art. 5 of the FPO.

Perhaps unsurprisingly against the background of s.21(3) FSMA, the rules apply not only to promotions made within the UK, to UK consumers, but also have limited extraterritorial effect in applying “to financial promotions that are capable of having effect in the UK” irrespective of the country of origin. The FCA’s guidance on the rules makes clear that:

“promotions do not need to be specifically directed at UK consumers to be capable of having effect in the UK. If a UK consumer can access and respond to cryptoasset promotions to engage in the cryptoasset activities, such as through websites, apps and/or social media, it is likely that those promotions will be capable of having an effect in the UK. This applies regardless of the location of the firm making the promotion or who it was primarily aimed at.”

In summary, the promotion of cryptoassets that are capable of having effect in the UK shall be restricted to four permitted routes:

1. Promotions communicated by an “authorised person”;
2. Promotions made by an unauthorised person, but where approved by an authorised person;
3. Promotions communicated by or on behalf of a cryptoasset business registered with the FCA under the Money Laundering Regulations 2017 (‘MLR’) in reliance of the exemption under Art. 73ZA of the FPO (coming into force on 7 October 2023 – registered cryptoasset exchange or custodian wallet providers).
4. Promotions within existing exemptions under the FPO – principally institutional investors. Importantly, HNW and sophisticated investor exemptions do not apply.

The rules include:

• Fair clear and not misleading – the rules subject promotions to the requirements of COBS 4.2 on fair, clear and not misleading communications. 
• A ban on incentives – including ‘refer a friend’ rewards, new-joiner bonuses and time-limited offers.
• A mandatory 24-hour ‘cooling-off’ period – COBS 4.12A.18R – applicable from the first viewing of a direct offer financial promotion (‘DOFP’) by first-time investors with a prohibition on such consumers ‘opting out’. Firms may proceed with other parts of the consumer journey during the cooling-off period (KYC/AML, etc).
• Mandatory client categorisation – every investor must be categorised as restricted, high net worth, or a certified sophisticated investor before a DOFP can be made. Investors must also sign a declaration that they meet the relevant criteria. The COBS 4.12A.21R self-certified sophisticated categorisation does not apply (except to P2P agreements), and all certifications are valid for a maximum of 12 months, after which firms must re-categorise investors if they wish to make further DOFPs.
• Appropriateness assessment – the relevant firm must abide by the general COBS 4.12 appropriateness guidance for restricted mass market investments. An appropriateness assessment is only required on the first occasion that a particular retail client responds to a DOFP relating to a specific type of restricted mass market investment. See: COBS 4.12A.16G.
• Risk warnings – COBS 4.12A.20R – in the terms prescribed, this must address the investor by name. Further, generalised risk warnings must be given, prescribed by the guidance including the COBS 4.12A.11R warning:

Don’t invest unless you’re prepared to lose all the money you invest. This is a high‐risk investment and you should not expect to be protected if something goes wrong.

Breaches of the rules on content and procedure for DOFPs will be subject to the ordinary enforcement regime. As the Authority makes clear in its policy statement, promotions that are not made using one of four permissible routes will be in breach of s.21 FSMA: a criminal offence punishable by up to two years’ imprisonment, the imposition of a fine, or both.

Effect of the new rules

To those subject to the FCA’s regulation of other investment products, the new rules will seem familiar, ostensibly bringing the requirements for promotion of qualifying cryptoassets in line with other high-risk investments. The changes are, however, significant.

The rules form part of a tide of regulation in the UK which has been coming in for several years; a tide which has now ossified the status of cryptoassets as investments rather than a mechanism of gambling. In line with that philosophy, the rules have the (desired) effect of ensuring a level of regulatory oversight and scrutiny commensurate with the risk such products pose to retail customers. At their heart, the rules clearly have aims of consumer welfare and seek to protect UK consumers against offers which ignore, misrepresent, or trivialise the risks associated with the underlying investment. The Authority’s concern continues to extend beyond UK providers:

“Anyone who continues promoting cryptoassets to UK customers past the October deadline without complying with the rules, may be committing a criminal offence.”

Implications for POCA and asset recovery

The increasing creep of regulation into cryptocurrency provision is a development which shall be of great interest not only to investors, but to those with an interest in the recovery of assets ‘converted’ into crypto.

Recent years have seen a significant increase in the number of crypto fraud cases before criminal courts. Initial Coin Offering (‘ICO’) frauds, for example this allegation relating to Telecoin in which members of Mountford Chambers acted for the defendants, have seen unregulated individuals or enterprises market cryptocurrencies to unsophisticated, often vulnerable investors. Recovering assets in those circumstances has involved lengthy and costly proceedings seeking to prove criminal conduct, usually in the form of fraud by false misrepresentation by the vendor, with (attempted) recovery following criminal conviction.

Does that high bar remain? Practitioners facing such cases, and cases where assets are held in cryptocurrency more generally, may consider that the new rules lower the bar for recovery of assets in such cases dramatically.

The implications of the new rules can be seen by posing the familiar questions from Part 5 POCA to such facts. Is there (a) property (b) obtained by unlawful conduct?

a) Is there property?

Where funds were never converted into cryptoassets, this question remains simple. Where such a conversion has taken place, it is now well-settled that assets invested in cryptocurrency are ‘property’ within the meaning of the Proceeds of Crime Act 2002 and may therefore be subject to proprietary orders:

“a crypto asset might not be a thing in action on a narrow definition of that term, but that does not mean that it cannot be treated as property […] They meet the four criteria set out in Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth [1965] 1 AC 1175 as being definable, identifiable by third parties, capable in their nature of assumption by third parties, and having some degree of permanence […] crypto currencies are a form of property capable of being the subject of a proprietary injunction” –  AA v Persons Unknown et al [2019] EWHC 3556 (Comm) per Bryan J

b) Was that property obtained by unlawful conduct?

Though s.240 POCA talks of property obtained through unlawful conduct, the gloss of s.242 makes clear that property will be so obtained if obtained “by or in return for the conduct”.

In the ‘traditional’ ICO fraud, demonstrating that property was obtained by unlawful conduct would require proof of fraud – false representation with intent to cause a loss (for example). Thus, the practitioner seeking recovery of the appropriated assets would have to grapple with the Fraud Act 2006 and defeat suggestions that risks were communicated to prospective investors.

However, the new rules have the effect of rendering the offering of such crypto ‘schemes’ unlawful where not conducted through one of the four permitted gateways: a breach of s.21 FSMA amounting to a criminal offence. Demonstrating that a vendor did not have in place the sufficient registration or authority is, of course, a much less onerous task.

But does the commission of the s.21 FSMA offence sufficiently ‘taint’ the acquired and/or converted asset so as to render it recoverable, without more?

Recent authority suggests that it does.

In Fresh View Swift Properties Ltd v Westminster Magistrates’ Court [2023] EWHC 605 (Admin) discussed in detail in the Mountford Chambers blog here, the Court was faced with transfers remitted between the UK and Nigeria by an unregistered money service business (‘MSB’.) Considering the implication of trading without registration, Mostyn J reasoned:

1. 18. As the conduct of Payer X in paying the money into Michael K’s account was not unlawful, that conduct cannot be a reason for making the money recoverable.

1. 19. However, I have reached the conclusion that Michael K must have engaged in “conduct”, as an operator of an unlicenced MSB, to receive that money. That conduct would have been as follows:

       i) he would have offered his services to people or entities in the position of the claimant as an unlicenced MSB;
       ii) in his capacity as an operator of an unlicensed MSB he would have set up at least one bank account to receive money with which to pay to people or entities in the position of the claimant (‘the receiving account’);
       iii) he would have arranged for funds to be paid by Payer X from its bank account (‘the paying account’) into the receiving account;
       iv) for that purpose he would have provided the details of the receiving account to Payer X to enable the funds to be transferred to it; and
       v) he would have arranged the date and time of the transfer of funds from the paying account to the receiving account.

1. 20. As explained above, the operation by Michael K of an unlicenced MSB was a criminal offence. The steps taken by him to facilitate the receipt by him of £67,372.21 in his receiving account from the paying account were therefore unlawful steps under the criminal law of all parts of the UK.
   21. My essential reasoning is that the transfer of money from Payer X’s bank account to Michael K’s bank account requires “conduct” by both Payer X as transferor and Michael K as transferee. It is not realistic to view Michael K’s receipt of the money as being purely passive.

The analogy to the operator of an unregistered or permitted cryptoasset promotion is irresistible: the operation of the scheme and receipt of assets to ‘purchase’ assets can properly amount conduct on the part of the transferee. Where the transferee is in breach of s.21 FSMA, that conduct will necessarily be unlawful.

The necessary consequence of this analysis is that the October 2023 rules significantly lower the bar for civil recovery of ‘invested’ assets in cases of unregulated crypto sales. This may have far-reaching consequences for the speed with which crypto assets can be recovered in civil contexts; and in the case of ICO frauds would seem to remove entirely the requirement to demonstrate fraud – requiring only proof that an asset (existent or not) was sold outside the four permissible gateways.

From a consumer protection point of view, the development represented by the new rules marks a significant advancement. The rules may also result in a more general shift in recovery strategies to earlier, quicker freezing and recovery of cryptoassets, shifting the burden onto civil recovery and proving a useful tool for the enterprising asset recovery practitioner.

Whether these rules have the effect of spelling the end of ICO frauds and hailing an increase in NFT-based schemes remains to be seen. Nevertheless, the rules foreshadow the arrival of the Economic Crime and Corporate Transparency Bill, which makes numerous significant crypto-specific insertions to the civil forfeiture and confiscation regimes of POCA, including provisions relating to Crypto Wallet Freezing Orders. These amendments, which will be discussed in subsequent articles, will be of interest to prosecuting authorities, relevant enforcement agencies, civil asset recovery specialists, criminal defence practitioners, and all those who operate in the cross-border debt recovery market. 

About the authors

James Lloyd is the Deputy Head of the Mountford Chambers Regulatory Practice Group. He has considerable experience acting for professional regulators and regulated professionals. He recently acted as junior alone for four of five applicants in Page & Ors v Financial Conduct Authority [2022] UKUT 124 (TCC); one of the largest Upper Tribunal cases of recent years, relating to the transfer of c.1,500 retail customer pensions into loan notes and bonds and involving: COBS compliance; detailed consideration of IFA duties in respect of products; due diligence; duties relating to outsourced activities and conflicts of interest; the requirements of honesty and integrity for regulated IFAs; limitation; and de facto directorship. James is frequently instructed in regulatory and professional discipline cases involving regulated professions, including those working within financial services, police officers, solicitors, architects, teachers and healthcare professionals. His advisory practice spans professional regulation, professional discipline and data protection.

Laurence Harris has a particular interest in fraud, corporate crime, financial regulation, and cases with a cross-border dimension. He has helped prepare defences to money laundering charges, POCA enforcement, civil claims under FMSA 2000, US Department of Justice investigations, and Part 2 extradition requests. He is also frequently instructed in professional discipline cases.

Related content from Mountford Chambers

Fresh View Ruling Offers Clarity On Forfeiture Orders – Joseph Sinclair discusses the judgment in Fresh View Swift Properties Ltd v Westminster Magistrates’ Court [2023] EWHC 605 (Admin)

Cryptocurrencies have given rise to an entire new criminal industry – Mark Watson discusses regulation of cryptocurrencies in light of the Terra and Luna ‘crashes’.

When life takes your crypto, give LMN aid – analysis of the judgment in LMN v Bitflyer Holdings Inc. and others [2022] EWHC 2954 (Comm)

Cryptocurrency in Financial Crime – Tom Edwards examines the rise and regulation of cryptocurrency and the implications for practitioners in criminal cases.