It’s been a busy 2018 for cryptocurrency enforcement by the SEC. Following statements by Chair Jay Clayton and Co-Director of Enforcement Stephanie Avakian announcing various cryptocurrency concerns, sweeps and initiatives, several recent Commission enforcement actions have backed up its big talk. Nearly one year after the creation of Enforcement’s Cyber Unit, cryptocurrency enforcement has grown into a vital element of the agency’s mission to protect main street investors.
Let’s take a look at some recent developments in this area.
- ICO Sellers May Have to Register as Broker-Dealers
Last month, the SEC brought its first case charging a digital token trading website, TokenLot, and its two founders, with operating as an unregistered broker-dealer in violation of Section 15(a) of the Exchange Act and selling unregistered securities in violation of Sections 5(a) and (c) of the Securities Act. TokenLot had touted itself as an “ICO Superstore,” soliciting orders from over 6,000 investors and handling more than 200 different tokens.
In a settled administrative proceeding, TokenLot agreed to disgorge $471,000 plus interest, its founders each paying civil penalties and agreeing to various industry bars. Moreover, TokenLot agreed to engage a third party to destroy its remaining holdings of digital assets.
The TokenLot action is significant for a few reasons. First, it is one of a handful of non-fraud-based enforcement actions in the cryptocurrency space. Nowhere in its order did the Commission allege that TokenLot’s customers were duped or defrauded. Second, the destruction of digital assets is a unique remedy and to date, it is unclear when and how TokenLot has complied, or how it has documented its compliance.
Third, the Section 15(a) charge suggests that the Commission’s Division of Trading and Markets has taken the view that selling and reselling digital tokens falls within being the definition of “engaged in the business of effecting transactions” such that broker-dealer registration is required. This could signal a wave of non-fraud enforcement actions against digital token gatekeepers and middlemen.
- Shutting Down ICO Frauds Before They Start
Just two weeks ago, the SEC shut down Blockvest, a self-described crypto currency exchange and index fund, and froze its assets. (The Blockvest website remains live… and looks great!). Blockvest was formed in April 2018 and, per the SEC’s press release and complaint, did not defraud any investors… yet. However, on its website and marketing materials, Blockvest made HoweyCoin look amateurish.
Among other claims, Blockvest touted its ICO as SEC approved and registered (it wasn’t) and used the SEC’s seal on its offering materials (aggressive). Blockvest attempted to bolster its operation by claiming Deloitte as its auditor and partner (also not true). Blockvest also created the “Blockchain Exchange Commission” or “BEC” – a fake regulator – to add further veneer of legitimacy. (It did not help that the BEC’s seal and mission statement were lazy imitations of the SEC’s seal and mission statement, or that the BEC shared an address with the SEC.)
The Commission’s federal district court complaint and TRO have shut Blockvest down, for now. What makes this action remarkable is that there are no allegations that, as of the date of filing, Blockvest has stolen investor funds. Indeed, the complaint makes clear that
Unless restrained and enjoined, [Blockvest founder Reginald Buddy] Ringgold is scheduled to appear at two ‘VCs, Angels, Crypto and ICOs” events in Los Angeles on October 9, 2018 and in Orange County on October 11, 2018, where he will likely continue promoting Blockvest and the BEC in order to raise additional monies from investors through his fraudulent misrepresentations and scheme to defraud – including for Blockvest’s intended December 2018 ICO.
Shutting down Blockvest is a no-brainer. Given its outrageous and easily disprovable claims, there is no question that Blockvest’s ICO would have led to the same result as wiring money to Nigerian email scammer. The SEC deserves as much credit for acting quickly and preemptively, but this episode raises a major concern: if someone like Ringgold was invited to two seemingly legitimate ICO conferences where there existed a non-zero chance that he would recruit investors, ICO investors as a whole could be in trouble.
- ICO Investment Advisors and Funds Must Properly Disclose and Register
On the same day that it announced the TokenLot settlement, the SEC settled an enforcement action with Crypto Asset Management LP (CAM), a fund that invested 40% of its assets in digital securities. CAM was charged with violations of Section 7(a) of the Investment Company Act of 1940 for its failure to register the fund with the Commission as an investment company (Admin Order at ¶12).
Like TokenLot, and even Blockvest, the Commission made no allegation that CAM’s investors were harmed. However, unlike the TokenLot action, CAM’s adviser, a hedge fund manager, was charged with making misrepresentations as to the registration status of the fund (as well the incorrect claim that CAM was the “first regulated crypto asset fund in the United States.”).
Failing to register a fund as an investment company seems like a pretty obvious and basic violation of securities laws… and it is. But the takeaway from the CAM action is that the Commission will scrutinize the disclosures of investments and investment advisors who dabble in cryptocurrencies and digital assets.
The TokenLot, Blockvest and CAM enforcement actions offer a glimpse into the evolution of the Commission’s cryptocurrency enforcement priorities and expanding charging options. Treatment of ICO resellers as potential broker-dealers and ICO funds as investment companies confirms that there is a place for ICO gatekeepers and investors who play by the Commission’s rules. Similarly, the Commission’s efforts to weed out obvious bad actors before any losses occur will promote confidence among ICO investors and incentivize proper registration and disclosures.
In sum, the latest batch of enforcement actions is a positive sign: a change from the “all fraud, all the time” mentality about cryptocurrencies to an enforcement regime that gives the industry some benefit of the doubt