Restructuring

This is the third post in our Bitcoin Bankruptcy series on the Weil Bankruptcy Blog.  In the spring of this year, the shutdown of Japanese bitcoin exchange Mt. Gox made us think about what might have happened if Mt. Gox were a U.S.-based bitcoin exchange.  We began the series by taking a general look at what bitcoins are and how they work, and then we started to consider whether a hypothetical U.S.-based bitcoin exchange would be eligible to file for chapter 11 relief.

Our last Bitcoin Bankruptcy post concluded that a U.S.-based bitcoin exchange likely would be eligible for chapter 11 relief unless it were a stockbroker, commodity broker, or a bank that is not a multilateral clearing organization.  Today, we examine whether a bitcoin exchange might constitute a “stockbroker” under the Bankruptcy Code.
The Text of the Bankruptcy Code
Under section 101(53A) of the Bankruptcy Code, a “stockbroker” is an entity “with respect to whom there is a customer” and “that is engaged in the business of effecting transactions in securities for the account of others” or on a proprietary basis.  Whether a bitcoin exchange constitutes a “stockbroker” depends on two questions:  First, does the bitcoin exchange have a “customer”?  Second, are bitcoins “securities”?
Under section 741(2) of the Bankruptcy Code, a “customer” is a person who, among other things, the debtor “deals with as principal or agent . . . in the ordinary course of such person’s business as a stockbroker” and for whom the debtor holds “securities . . . for safekeeping; with a view to sale; to cover a consummated sale; pursuant to a purchase; as collateral under a security agreement; or for the purpose of effecting registration of transfer . . . .”  The bitcoin exchange may have “customers” because it arguably holds bitcoins “for safekeeping,” “with a view to sale,” or “pursuant to a purchase.”  The bigger question, of course, is whether bitcoins constitute “securities.”
Under section 101(49) of the Bankruptcy Code, the term “security” has an extremely broad definition.  It includes, among other things, a “note; stock; . . . debenture; . . . certificate of deposit; . . . [and any] other claim or interest commonly known as a ‘security’ . . . .”  Despite the breadth of this definition, a bitcoin does not clearly fall within any of these categories.  Notes, debentures, and certificates of deposit are all debt instruments.  A bitcoin, by contrast, does not evidence any kind of an obligation—it is generally thought to have its own independent value.  A “stock” is an equity investment in an enterprise, but there appears to be no enterprise underlying bitcoins.  Bitcoins are not evidence of equity ownership in a business; rather, they are standalone units of value that serve as a medium of exchange among those who accept bitcoins as payment for goods or services.
Perhaps the best argument for characterizing a bitcoin as a “security” is by viewing it as an “interest commonly known as a ‘security.’”  Yet this interpretation may suffer from the same problem as the term “stock”: the bitcoins themselves do not seem to be an investment in any underlying enterprise.  Accordingly, it appears to be difficult—though perhaps not impossible—to view a bitcoin exchange as a “stockbroker” under the text of the Bankruptcy Code because of the problems involved in characterizing a bitcoin as a “security.”
Lack of Regulatory Guidance
It is important to note that the Securities Exchange Commission, the Financial Industry Regulatory Authority, and courts generally have not yet weighed in on whether they consider bitcoins to be “securities.”  The SEC and FINRA both have issued recent warnings advising investors to exercise caution when investing in bitcoins.  Neither warning, however, offers guidance as to those organizations’ views on the legal nature of bitcoins.
MarketWatch related the views of Stephen Harbeck, the president of the Securities Investor Protection Corporation, regarding bitcoins’ legal status:

“If you deposited cash of any country backed by a national currency with a brokerage firm, that is considered cash, but that’s not what a Bitcoin is,” Harbeck said. “It sounds like a commodity that can be literally grown in a computer, and we don’t protect against commodities transactions. . . . I would be very hesitant to say — until we get a lot more clarity on it from the regulators — that we would protect any transaction denominated in Bitcoins.”

Yet this statement clearly cannot be understood as a conclusion by SIPC that bitcoins are not securities.  In any event, nothing prohibits Congress or state legislatures from attempting to clarify bitcoins’ legal status, whether as securities, commodities, or otherwise.
For purposes of our continuing discussion, we assume that a U.S.-based bitcoin exchange would not constitute a “stockbroker” under the Bankruptcy Code.  Accordingly, our hypothetical bitcoin exchange would be eligible for chapter 11 relief unless it is a commodity broker or a bank that does not operate a multilateral clearing organization.  We will look more closely at those legal frameworks in the future.
As a reminder, the Weil Bankruptcy Blog does not provide or purport to provide legal advice on bankruptcy, securities, or any other areas of law.  The discussion herein reflects the opinion of the author, not that of Weil, Gotshal & Manges LLP.  This discussion is strictly hypothetical and may not be relied upon for the purpose of trading bitcoins, securities, or any other instrument of value.